Nagendra Marisetty IAPM Exercises

UNIT – I: BOND VALUATION

Problem 1. A Rs 1000 bond matures in 20 years and offers a 9% coupon rate.
The
required rate of return is 11%. Compute the bond value?

Sol:
n
Int i RV
Formula Bond Value =  (1 + r )
i =1
i
+
(1 + r ) n

BV = Bond Value RV = Redemption (Redeem) Value

r = Required rate of return, Int = Interest
n = maturity FV = Face value

From the above problem coupon rate is 9%, r is 11%, FV is 1000 and n is 20
years. Face value and Redemption value is same in this problem, because they
didn’t give any redemption value separately.

So, we need find out Interest and Bond value

Always interest calculation on Face value

Therefore face value is 1000 and coupon rate is 9%, then interest is
Int = 1000 * 9% = 1000 * 9/100 = 90

Now we need to find Bond Value

20
90 1000
=  (1 + 11 / 100)
i =1
i +
(1 + 11 / 100) 20

20
90 1000
=  (1 + 0.11)
i =1
i
+
(1 + 0.11) 20

First denominator looks Present value annuity factor, second one looks line
Present value factor.

First one is PVAF 11% @ 20 years period = 7.963

Second one is PVF 11% @ 20 years period = 0.124

Now BV = 90 * PVAF 11 %,, 20 y

+ 1000 * PVF 11 %, 20 y

= 90 * 7.963 + 1000 * 0.124

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Bond value is = 716.67 + 124 = 840.67

Conclusion: we can buy the bond at 840.67 to get 11% return

Problem 2. A 5000 bond with a 10% coupon rate matures in 8 years and currently
sells at 97%, is this bond a desirable investment for an investor whose required
rate of return is 11%?

Sol:
Given values
Face value = 5000, Redeem value = 5000
Maturity n = 8 years Required rate of return = 11%
Coupon rate is = 10% Present selling value = ?
Bond Value = ? Interest = ?

Present selling value is 97% on face value

= 5000 * 97% = 5000 * 97/100 = 4850

Then, Interest is 10% on face value, that is 5000 * 10/100= 500

Now we need find Bond Value

n
Int i RV
Formula Bond Value =  (1 + r )
i =1
i
+
(1 + r ) n

8
500 5000
= +
i =1 (1 + 11 / 100) i (1 + 11 / 100) 8

8
500 5000
=  (1 + 0.11)
i =1
i
+
(1 + 0.11) 8

= 500 * PVAF 11 %,,8 y

+ 5000 * PVF 11 %,8 y

= 500 * 5.146 + 5000 * 0.43

= 4743

So, present selling value is higher than what the bond value.

Therefore it is not good for buying the bond

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Problem 3. Fallowing information is available in respect of bond

Face Value = 1000, Coupon rate = 8%, life is 3years, maturity at par and expected
yield 10%. How much price an investor should be ready to pay for the bond if the
interest rate payable half yearly or yearly basis?

Sol:
Given values, Face Value = 1000 Redeem Value = 1000
Coupon rate = 8% Maturity = 3years
Required rate of return = 10%

From the above problem need to find out bond value, if interest paid annually and
semi annually.

If interest is going to pay semi annually, then interest and required rate of
return will become half and maturity will become double.

Valuation of bond if interest is payable half yearly-

Interest @ 8% on 1000 on 80, for semi annually it will become half that is
40
Required rate of return is 10%, for semi annually it will become half that
is 5%
Maturity is 3years, for semi annually it will become double that is 6years
n
Int i RV
Formula Bond Value =  (1 + r )
i =1
i
+
(1 + r ) n

6
40 1000
Now bond value for semi annually =  (1 + 0.05)
i =1
i
+
(1 + 0.05) 6

= 40 * PVAF 5%,, 6 y
+ 1000 * PVF 5%,6 y

= 40 * 5.076 + 1000 * 0.746

= 949.04
3
80 1000
Now bond value for annually =  (1 + 0.10)
i =1
i
+
(1 + 0.10) 3

= 80 * PVAF 10 %,, 3 y
+ 1000 *
PVF 10 %,3 y

= 80 * 2.487 + 1000 * 0.751

= 949.96

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Nagendra Marisetty IAPM Exercises

Yield to Maturity

Yield – Yield is a measure of the income an investor receives on his investment

until maturity. Required yield or required rate is the minimum income a bond
must offer in order to attract investors.

Yield Curve – Yield curve depicts the relationship between time to maturity and
yields for a particular category of bonds at a particular point of time.
n
Int i RV
Formula for Yield to Maturity (YTM) B0 =  (1 + YTM )
i =1
i
+
(1 + YTM ) n

B = Value of the bond at present

0
Int = Interest
RV = Redemption Value n = Maturity

Int
Current Yield – Formula for Current Yield =
B 0

B 0
= Value of the bond at present Int = Interest

Problem 1: A bond of 10,000 bearing coupon rate 12% and redeemable in 8years
at par is being traded at 10,600 find out current yield and Yield to maturity?

Sol: Given Values

B = Value of the bond at present = 10,600,

0
Int = Interest
RV = Redemption Value = 10,000 n = Maturity = 8years

Coupon rate = 12% Face Value = 10,000

Interest is 12% on Face value that is 10,000 * 12/100 = 1200

Now need to find out Yield to maturity – “yield to maturity need to calculate
on trail and error basis. Checking of YTM is always, if Bond value at present
higher than the face value then need to check YTM’s are lesser than the
Coupon rate and Bond value at present lesser than the face value then need
to check YTM’s are higher than the Coupon rate”

In this problem Bond Value at present is 10,600 and Face value is 10,000

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So, Bond value is higher than the Face value, now we need to check YTM’s are
lesser than coupon rate.
8
1200 10000
YTM at 11% =  (1 + 0.11)
i =1
i
+
(1 + 0.11) 8

= 1200 * PVAF 11 %,,8 y

+ 10000 * PVF 11 %,8 y

= 1200 * 5.146 + 10,000 * 0.434

= 10, 515

At 11% value is lesser than the Bond value at present, so we need to check another
YTM that is 10%
8
1200 10000
YTM at 10% =  (1 + 0.10)
i =1
i
+
(1 + 0.10) 8

= 1200 * PVAF 10 %,,8 y

+ 10000 * PVF 10 %,8 y

= 1200 * 5.335 + 10,000 * 0.467

= 11,072

At 10% value is higher than the Bond value at present means YTM is between
10% and 11%.

“Trail and error process we need to do till where B 0

is middle of two
YTM’s”

Now need to find out exact YTM value

MainYtmvalue − B0
YTM = Main YTM% +
Mainytmvalue − Anotherytmvalue

Here we are checking between 10% and 11%, now main YTM is 10% and another
YTM is 11%
11,072 −10,600
YTM = 10% + = 10% + 0.85 = 10.85%
11,072 − 10,515

Short Cut Methods –

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(RV − B )
Int + 0

n
1. Approximate YTM =
(RV + B ) 0

B = Value of the bond at present = 10,600,

0
Int = Interest = 1200
RV = Redemption Value = 10,000 n = Maturity = 8years

1200 +
(10,000 − 10,600 )
Approximate YTM = 8
(10,000 + 10,600 )
2

= 10.92%

Int +
(RV − B ) 0

2. Approximate YTM = n
0.4 * RV + 0.6 * B0

Problem2:
Market price is 107, Maturity date 31-12-12,
Face Value is 100, Callable on 01-01-09
Callable Value is 105, Date of Purchase on 01-01-07
Coupon rate is 12% Interest payable annual
Calculate current yield and Yield to Call?

Sol:
Int
Current Yield =
Currentpri ceB0

Interest is 12% on Face Value, that is 12% * 100 = 12

12
Current Yield = = 11.21%
107

n
Int i RV
Yield to Call (YTC) =  (1 + YTC )
i =1
i
+
(1 + YTC ) n

Given values in this problem is

B 0 = Market Price = Present value = 107,
RV = Redemption Value is, in this problem need to find YTC means callable
value is itself is Redemption value = 105,
Maturity = this value is from purchase date to callable date, that is 2years,

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“Present Bond value, i.e. Market price is higher than the Face Value, means need
to check lesser than Coupon rate”
2
12 105
YTC at 11% =  (1 + 0.11)
i =1
i
+
(1 + 0.11) 2
= 12 * 1.713 + 105 * 0.812
= 105.82

So, 105.82 is lesser than the 107, need to check 10%

2
12 105
YTC at 10% =  (1 + 0.10)
i =1
i
+
(1 + 0.10) 2
= 12 * 1.736 + 105 * 0.826
= 107.57
107.57 is lesser than the 107, means YTC will be between 10% and 11%

MainYtcvalue − B0
YTC = Main YTC% +
Mainytcvalue − Anotherytcvalue

107.57 − 107
= 10% + = 10.33%.
107.57 − 105.82

(RV − B0 )
Int +
Short Cut Method – YTC = n
0.4 * RV + 0.6 * B0

12 +
(105 − 107 )
= 2
0.4 *105 + 0.6 *107

= 10.35%.

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Nagendra Marisetty IAPM Exercises

EQUITY VALUATION
a. Valuation Based on One-year Holding Period: If an investor intends to buy
a share now and to keep it for a period of one year after which he expects to sell
it for a price, the valuation of share depends on the discounted value of expected
price after one year.

D1 P1
The value of the share is P 0 = +
(1 + k e )1
(1 + k e )1
P 0 = Present Value D 1 = Expected Dividend
P 1 = Expected Price k e = Required rate of return

Problem1: A dividend of Rs.3 and selling price of Rs. 20 is expected after 1 year.
Find the value of the share today, assuming a required rate of return of 20%?

D1 P1
Sol: The value of the share is P 0 = +
(1 + k e )1 (1 + k e )1

3 20
P0 = +
(1 + 20%) 1
(1 + 20% )1
3 20
= +
(1 + 0.20) 1
(1 + 0.20)1
= 2.50 + 16.67 = 19.17

b. Constant Growth in Dividends:

D1 D (1 + g )
The value of the share is P 0 = = 0
(k e − g ) (k e − g )

P 0 = Present Value D 1 = Expected Dividend,

D 0 = Present Dividend
g = Growth rate k e = Required rate of return

D1
The above equation can be write as k e = +g
P0

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Nagendra Marisetty IAPM Exercises

Problem2: XYZ Ltd has just paid its annual dividend of Rs. 3 per shares having
face value of Rs. 10. The dividend rate is expected to grow at the rate of 8% p.a
forever. The company belongs to a risk group for which the equity capitalization
rate of 14% is found to be consistent. What is the intrinsic value of the share?

Sol: Given values D 0 = 3, g = 8%, k e = 14%

D0 (1 + g )
The value of the share is P 0 =
(k e − g )

3(1 + 8%) 3(1 + 0.08)

= =
(14% − 8%) (0.14 − 0.08)

3.24
= = 54.
(0.06)

Problem3: Equity shares of Badarpur Gas Ltd. are currently selling at Rs 60. The
company is expected to pay dividend of Rs 3 after 1 year, with a growth rate of
8%. Find out the implied required rate of return of the equity investors.

Sol: Given Values D 1 = 3, g = 8%, k e =? , P 0 = 60

Need to find required rate of return

D1
Formula is k e = +g
P0

3
= + 0.08
60
= 13%

Variable Growth in Dividends-

Zero growth rate and the constant growth rate assumptions of dividend patterns
are extreme assumptions. In a practical situation, the dividend from a company
may show one growth rate for few years, fallowed by another growth rate for next
few years and then yet another growth rate for next few years, and so on.

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Two Growth Model –

n
Divi Pn
Formula P 0 =  (1 + k ) + (1 + k )
i =1
n
e e

Problem4: Air Mail Ltd has just paid a dividend of Rs 2 per share. In view of the
rapid growth of the company, the dividend is expected to grow at 20% p.a. for
next 3 years. After that the growth process will slow down and the earnings are
expected to grow only at 7% p.a. infinitely. In view of the risk involved in the
investment, a return of 22% is considered appropriate. Find out the price an
investor should be ready to pay for the shares.

Sol: The above case can be taken up as a Two growth model

Given values D 0 = 3, k e = Required rate of return = 22%

Primary growth g 1 = 20% Secondary growth g 2 = 7%
Duration of primary growth is n = 3

In the given situation the Present values (PV) of Dividend for first 3years is

Year Dividend PVF (22 ,n ) Present

Values
Div*PVF
D1 2(1+20%)=2(1+0.20)=2(1.2)=2.40 0.820 1.97
D2 2.40(1+0.20)=2.40(1.2)=2.88 0.672 1.94
D3 2.88(1+0.20)=2.88(1.2)=3.46 0.551 1.91
Total =5.82

Present dividend value is = 5.82

D4 D (1 + g 2 )
Value of the share at the end of year 3, P 3 = = 3
ke − g 2 ke − g 2

3.46(1 + 0.07) 3.70

= = = 24.67
0.22 − 0.07 0.15

Value of the share today, P 0 = Present dividend value + P 3

= 5.82 + 24.67 * PVF (22%,3)
= 5.82 + 24.67 * 0.551
= 19.41

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Problem5: Current dividend paid by a company is Rs 1, which is expected to

grow at 12% p.a. for next 5years after which is expected to grow 6% per
perpetuity. Find out the value of the share if the investors require a minimum
return of 10%.

Sol: The above case can be taken up as a two growth model

Given values D 0 = 1, k e = Required rate of return = 10%

Primary growth g 1 = 12% Secondary growth g 2 = 6%
Duration of primary growth is n = 5

In the given situation the Present values (PV) of Dividend for first 5years is

Year Dividend PVF (10%,n ) Present

Values
Div*PVF
D1 1(1+12%)=1(1+0.12)=1(1.12)=1.12 0.909 1.02
D2 1.12(1+0.12)=1.12(1.12)=1.25 0.826 1.03
D3 1.25(1+0.12)=1.25(1.12)=1.40 0.751 1.05
D4 1.40(1+0.12)=1.40(1.12)= 1.57 0.683 1.07
D5 1.57(1+0.12)=1.57(1.12)=1.76 0.621 1.09
Total =5.26

Present dividend value is = 5.26

D6
Value of the share at the end of year 5, P 5 = =
ke − g 2

1.76(1 + 0.06)
= = 46.64
0.10 − 0.06

Present Value of P 5 is = P 5 * PVF (10%,5 ) = 46.64 * 0.621

= 28.96

Value of the share today, P 0 = Present dividend value + PV of P 5

= 5.26 + 28.96
= 34.22

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Nagendra Marisetty IAPM Exercises

Unit – II
Return
Realized Return or Historical Return
Expected Return or Probable Return
Realized Return
• Arithmetic Return (or) Average Return
• Geometric Return
• Harmonic Return
Exercise
Exercise: Calculate the AR, GR and HR of the following returns and show that
AR > GR > HR.
32, 35, 36, 37, 39, 41 and 43
1 (32+35+36+37+39+41+43) 263
AR is ∑𝑛𝑖=1 𝑅𝑖 = = = 37.57
𝑛 7 7
𝑛
GR is √𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑜𝑓 𝑎𝑙𝑙 𝑡ℎ𝑒 𝑛 𝑣𝑎𝑙𝑢𝑒𝑠
𝑛
= √𝑅1 ∗ 𝑅2 ∗ 𝑅3 ∗ … ∗ 𝑅𝑛 = (x * x * …*x ) ^1/n
1 2 n
7
= √32 ∗ 35 ∗ 36 ∗ 37 ∗ 39 ∗ 41 ∗ 43
7
= √102574442880
= 37.40
𝑛
H.R = 1
∑𝑛
𝑖=1 𝑥𝑖

7 7
H.R = 1 1 1 1 1 1 1 =
+ + + + + + 0.0312+0.0285+0.0277+0.0270+0.0256+0.0243+0.0232
32 35 36 37 39 41 43

7
= 0.1875 = 37.31

Hence, AR > GR > HR = 37.57 > 37.40 > 37.40

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Nagendra Marisetty IAPM Exercises

Expected Return
Exercise: An investor evaluating a stock and expecting the following returns from
the stock from coming year.
Situation Probability Return (%)
1 0.20 8
2 0.15 10
3 0.30 15
4 0.35 5
Calculate the expected return.
Solution:
Expected return 𝑅̅ = ∑𝑛𝑖−1 𝑃𝑖 𝑅𝑖
Situation Probability Return (%) 𝑃𝑖 𝑅𝑖
1 0.20 8 1.6
2 0.15 10 1.5
3 0.30 15 4.5
4 0.35 5 1.75
9.35

Expected Return = 9.35%

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Nagendra Marisetty IAPM Exercises

Return concepts –
• Absolute return
• Annualized return
• Average Return
• Actual Return

Example: An investor observed following prices for the period of 3 years and
invested in 100 stocks in the beginning of year. Calculate the absolute return,
annualized return, average return and actual return. Prices (Rs) at the end of year
is as follows for the period of 3 years respectively, 200, 150, 225.
Solution:
Absolute return
Starting of the price is Rs. 200
Ending of the price is Rs. 225
𝐸𝑛𝑑𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 −𝑆𝑡𝑎𝑟𝑡𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 + 𝐶𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤𝑠
Absolute return = * 100
𝑆𝑡𝑎𝑟𝑡𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒
225 − 200 + 0
= * 100 = 12.5 %
200

Annualized return is geometric return (This is compounding)

Yearly returns
Year Prices (Rs) Returns in dec Return in %
1 200 -
2 150 -0.25 -25
3 225 0.75 75
0.50 50

𝑃𝑟𝑎𝑠𝑒𝑛𝑡 𝑝𝑟𝑖𝑐𝑒 −𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑝𝑟𝑖𝑐𝑒 +𝐶𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤𝑠

Single period return =
𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑝𝑟𝑖𝑐𝑒
𝑛
Annualized return (Geometric return) = √(1 + 𝑅1)(1 + 𝑅2) … (1 + 𝑅𝑛) - 1
2
= √(1 + (−0.25))(1 + 0.75) - 1

= 2√(1 − 0.25)(1 + 0.75) - 1

2
= √0.75 ∗ 1.75 - 1 = (1.3125)1/2 – 1
= 1.1456 – 1 = 0.1456 = 14.56 %
1 (−25 + 75) 50
Average return = ∑𝑛𝑖=1 𝑅𝑖 = = = 25%
𝑛 2 2

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Nagendra Marisetty IAPM Exercises

Actual return

Invested in 100 stocks

Year Prices (Rs) Investment value Gain / Loss

1 200 20,000
2 150 15,000 - 5,000
3 225 22,500 7,500
Final gain / loss 2,500

𝐹𝑖𝑛𝑎𝑙 𝑔𝑎𝑖𝑛 / 𝑙𝑜𝑠𝑠 2500

Actual return = * 100 = * 100 = 12.5 %
𝐼𝑛𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 20000

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Nagendra Marisetty IAPM Exercises

Range
Problem: The following are the returns of a firm for the last 12 months
Months:1 2 3 4 5 6 7 8 9 10 11 12
Returns :80 82 82 84 84 86 86 88 88 90 90 92
(Returns in %)
Solution:
Highest return H = 92%
Lowest return L = 80%
Range = H – L = 92 – 80 = 12
𝐻− 𝐿
Coefficient of Range =
𝐻+ 𝐿

= 12 / 172 = 0.0697

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Nagendra Marisetty IAPM Exercises

MAD
“The average value of these deviations from the average return (A.R) is called
the mean the mean absolute deviation (MAD)”
Hint: Ignore the sign of the deviation by taking absolute value
1
For population MAD = ∑𝑛𝑖=1 І𝑅 − 𝜇 І
𝑁
1
For sample MAD = ∑𝑛𝑖=1 І𝑅 − 𝑅̅ І
𝑛
𝑀𝐴𝐷
For coefficient of MAD =
𝑅̅

Problem: Calculate the mean absolute deviation and its coefficient from
following data and compare the values.
Year Stock A Returns (%) Stock B Returns (%)
2006 23 36
2007 41 39
2008 29 36
2009 53 31
2010 38 47
Solution:
Mean
Year Stock A I R – 𝑅̅ I Stock B IR – 𝑅̅I
2006 23 23-36.8 = 13.8 36 36 – 37.8 = 1.8
2007 41 41-36.8 = 4.2 39 39-37.8 = 1.2
2008 29 29-36.8 = 7.8 36 36-37.8 = 1.8
2009 53 53-36.8 = 16.2 31 31-37.8= 6.8
2010 38 38-36.8 = 1.2 47 47-37.8 = 9.2
184 43.2 189 20.8

Stock A mean = 184 / 5 = 36.8

Stock B mean = 189 / 5 = 37.8
1
Stock A (MAD) = ∑𝑛𝑖=1 І𝑅 − 𝑅̅ І = 43.2/ 5 = 8.64
𝑛

Stock B (MAD) = 20.8 / 5 = 4.16

Stock A CoV MAD = 8.64 / 36.8 =
Stock B CoV MAD = 4.16 / 37.8 =
Semi Variance & Semi Deviation– It is considered only less than the average
values only

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Nagendra Marisetty IAPM Exercises

Calculate the semi variance and semi deviation from following data and compare
the values.
Year Stock A Returns (%) Stock B Returns (%)
2006 23 36
2007 41 39
2008 29 36
2009 53 31
2010 38 47
Solution
Year Stock A 𝑅 – 𝑅̅ (R – 𝑅̅ )2
2006 23 23-36.8 = -13.8 190.44
2007 41 41-36.8 = 4.2
2008 29 29-36.8 = -7.8 60.84
2009 53 53-36.8 = 16.2
2010 38 38-36.8 = 1.2
184 251.28
Stock A mean = 184 / 5 = 36.8
1 251.28
Semi variance = ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = = 125.64
𝑛 2

1
Semi deviation = √ ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = √125.64 = 11.20
𝑛

Stock B
Year Stock B R – 𝑅̅ (R – 𝑅̅ )2
2006 36 36 – 37.8 = -1.8 3.24
2007 39 39-37.8 = 1.2
2008 36 36-37.8 = -1.8 3.24
2009 31 31-37.8= -6.8 46.24
2010 47 47-37.8 = 9.2
189 52.72
Stock B mean = 189 / 5 = 37.8
1 52.72
Semi variance = ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = = 17.573
𝑛 3

1
Semi deviation = √ ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = √17.573 = 4.192
𝑛

𝑆𝑒𝑚𝑖 𝐷𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛
coefficient of Semi Deviation =
𝑅̅

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Nagendra Marisetty IAPM Exercises

Variance & Standard Deviation

Calculate the variance and standard deviation from following data and compare
the values.
Year Stock A Returns (%) Stock B Returns (%)
2006 23 36
2007 41 39
2008 29 36
2009 53 31
2010 38 47
Solution
Year Stock A 𝑅 – 𝑅̅ (R – 𝑅̅ )2
2006 23 23-36.8 = -13.8 190.44
2007 41 41-36.8 = 4.2 17.64
2008 29 29-36.8 = -7.8 60.84
2009 53 53-36.8 = 16.2 262.44
2010 38 38-36.8 = 1.2 1.44
184 532.8
Stock A mean = 184 / 5 = 36.8
1 532.8
Variance = ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = = 133.2
𝑛−1 4

1
Standard deviation = √ ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = √133.2 = 11.541
𝑛−1

Stock B
Year Stock B R – 𝑅̅ (R – 𝑅̅ )2
2006 36 36 – 37.8 = -1.8 3.24
2007 39 39-37.8 = 1.2 1.44
2008 36 36-37.8 = -1.8 3.24
2009 31 31-37.8= -6.8 46.24
2010 47 47-37.8 = 9.2 84.64
189 138.8
Stock B mean = 189 / 5 = 37.8
1 138.8
Variance = ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = = 34.7
𝑛−1 4

1
Standard deviation s = √ ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = √34.7 = 5.89
𝑛−1

𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐷𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛
coefficient of Standard Deviation =
𝑅̅

Page 19 of 51
Nagendra Marisetty IAPM Exercises

Exercise: Three stocks X, Y, Z and market returns as follows

Year Stock X Stock Y Stock Z Market
1 12 10 15 12
2 18 15 20 10
3 20 24 18 25
4 -15 20 15 16
5 24 18 15 8
6 4 -12 10 15
Comment on the performance of the three stocks on the basis of standard
deviation and coefficient of variation.
Solution:
Stock X
Year Stock X 𝑅 – 𝑅̅ (R – 𝑅̅ )2
1 12 1.5 2.25
2 18 7.5 56.25
3 20 9.5 90.25
4 -15 -25.5 650.25
5 24 13.5 182.25
6 4 -6.5 42.25
Total 63 1023.5
1 𝑛 63
Average return = ∑𝑖=1 𝑅𝑖 = = 10.5%
𝑛 6

1 1023.5
Standard deviation s = √ ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = √ = √204.7 = 14.30
𝑛−1 6−1

Stock Y
Year Stock Y 𝑅 – 𝑅̅ (R – 𝑅̅ )2
1 10 -2.5 6.25
2 15 2.5 6.25
3 24 11.5 132.25
4 20 7.5 56.25
5 18 5.5 30.25
6 -12 -24.5 600.25
Total 75 831.5
1 𝑛 75
Average return = ∑𝑖=1 𝑅𝑖 = = 12.5%
𝑛 6

1 831.5
Standard deviation s = √ ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = √ = √166.3 = 12.89
𝑛−1 6−1

Page 20 of 51
Nagendra Marisetty IAPM Exercises

Stock Z
Year Stock Z 𝑅 – 𝑅̅ (R – 𝑅̅ )2
1 15 -0.5 0.25
2 20 4.5 20.25
3 18 2.5 6.25
4 15 -0.5 0.25
5 15 -0.5 0.25
6 10 -5.5 30.25
Total 93 57.5
1 𝑛 93
Average return = ∑𝑖=1 𝑅𝑖 = = 15.5%
𝑛 6

1 57.5
Standard deviation s = √ ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = √ = √11.5 = 3.39
𝑛−1 6−1

Market
Year Market % 𝑅 – 𝑅̅ (R – 𝑅̅ )2
1 12 -2 4
2 10 -4 16
3 25 11 121
4 16 2 4
5 8 -6 36
6 13 -1 1
Total 84 182
1 𝑛 84
Average return = ∑𝑖=1 𝑅𝑖 = = 14%
𝑛 6

1 182
Standard deviation s = √ ∑𝑛𝑖=1(𝑅𝑖 − ̅̅̅
𝑅)2 = √ = √36.4 = 6.03
𝑛−1 6−1

𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐷𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛
coefficient of Standard Deviation =
𝑅̅
14.30 12.89 3.39
Stock X = ̅̅̅̅̅̅̅
= 1.362, Stock Y = ̅̅̅̅̅̅̅
= 1.032, Stock Z = ̅̅̅̅̅̅ = 0.218,
10.5 12.5 15.5
6.03
Market = ̅̅̅̅
= 0.431,
14

Descriptive Statistics
Particulars Return Risk (Standard Coefficient of Risk level
% Deviation) variation
Stock X 10.5 14.30 1.362 High
Stock Y 12.5 12.89 1.032 Moderate
Stock Z 15.5 3.39 0.218 Low
Market 14 6.03 0.431 Low

Page 21 of 51
Nagendra Marisetty IAPM Exercises

Expected Risk
Formula σ = √∑𝑛𝑖−1 𝑃𝑖 (𝑅𝑖 − 𝑅̅)2

Pi = Probabilities, Ri = Expected Return, 𝑅̅ = Average of Return

Calculation of Standard Deviation of Expected Returns

Returns Ri Probabilities Pi Pi * Ri (Ri -𝑅̅)^2 Pi(Ri - 𝑅̅)^2
-20 .05 -1.00 (-20-13) ^2 = 54.45
1089
-10 .10 -1.00 529 52.90
10 .20 2.00 9 1.80
15 .25 3.75 4 1.00
20 .20 4.00 49 9.80
25 .15 3.75 144 21.60
30 .05 1.50 289 14.45
1.00 𝑅̅ = 13.00 156.00

The Expected return 𝑅̅ = ∑ 𝑃𝑖 𝑅𝑖 = 13%,

The Standard Deviation (Expected risk) = √156 = 12.49%

Coefficient of Variation (CV) = Standard deviation / Return

= σ/𝑅̅ = 12.49/13 = .96

Higher CV is riskier.

Page 22 of 51
Nagendra Marisetty IAPM Exercises

BETA – Systematic Risk

β as a Measure of Risk: There is another measure of risk known as Beta. Beta

measures the risk of one security/portfolio is relation to the market risk. The
market risk is represented by variation in a bench mark index e.g. SENSEX,
NIFTY. Risk has been classified into systematic and unsystematic risks; Beta is
considered to measure systematic risk which cannot be diversified away.

∑𝑛 ̅̅̅̅̅ ̅̅̅̅̅̅
𝑖=1(𝑅𝑠𝑖 − 𝑅𝑠) (𝑅𝑚𝑖 − 𝑅𝑚 ) 𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑠𝑡𝑜𝑐𝑘 & 𝑚𝑎𝑟𝑘𝑒𝑡
Formula β = 2 =
𝜎𝑚 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 𝑜𝑓 𝑚𝑎𝑟𝑘𝑒𝑡

𝑟 𝜎𝑠 𝐶𝑜𝑟𝑒𝑙𝑎𝑡𝑖𝑜𝑛 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑠𝑡𝑜𝑐𝑘 & 𝑚𝑎𝑟𝑒𝑘𝑡 𝑎𝑛𝑑 𝑆𝑡𝑜𝑐𝑘 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛

Or β = =
𝜎𝑚 𝑚𝑎𝑟𝑘𝑒𝑡 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛

Covariance = correlation * SD of stock * SD of market

Rsi = Returns of stock, ̅𝑅𝑠
̅̅̅ = Average rate of return of stock
̅̅̅̅̅ = Average rate of return of market
Rmi = Return of market, 𝑅𝑚
2
𝜎𝑚 = Variance of market.
𝜎𝑠 = Stock Standard Deviation, 𝜎𝑚 = Market Standard Deviation

Share whose Beta factor is more than1 are considered as riskier than the
market, whose Beta is less than 1 are considered as less risky than the market
If Beta Value is Zero (Negative Beta) indicates negative relationship
between stock return and market return.
If Beta value, is One indicates stock return and market return are same

Relationship between σ and β: Both are used to measure of risk. However, both
measures are different. σ is measure of total risk, β is a relative index of market
risk or systematic risk.

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Nagendra Marisetty IAPM Exercises

Problem: Fallowing information is available in respect of market index and share

prices of XYZ ltd

Year Index (Rs) Share Price (Rs)

1996 218 10.90
1997 230 12.00
1998 248 13.30
1999 250 14.00
2000 282 18.00
2001 297 19.90
2001 288 18.10
2003 290 19.80
2004 320 22.50
2005 356 25.50
2006 371 28.00

Solution:
2
Estimation of 𝜎𝑚
Year Index Return Rm Deviation (Rm - 𝑅̅𝑚) (𝑅𝑚 – 𝑅̅𝑚)2
1996 218 - - -
1997 230 5.5 -0.1 0.00
1998 248 7.80 2.2 4.84
1999 250 0.80 -4.8 23.04
2000 282 12.8 7.2 51.84
2001 297 5.30 -0.3 0.09
2001 288 -3.00 -8.6 73.96
2003 290 0.70 -4.9 24.01
2004 320 10.3 4.7 22.09
2005 356 11.3 5.7 32.49
2006 371 4.20 -1.4 1.96
55.7 234

1 55.7
Market Average return 𝑅̅𝑚 = ∑𝑛𝑖=1 𝑅𝑚𝑖 = = 5.6%
𝑛 10
1 234
2
Market Variance 𝜎𝑚 = ∑𝑛𝑖=1(𝑅𝑚𝑖 − ̅̅̅̅̅̅
𝑅𝑚)2 = = 26,
𝑛−1 9
2
SD of Market is √𝜎𝑚 = 𝜎𝑚 = √26 = 5.1

𝑃𝑟𝑎𝑠𝑒𝑛𝑡 𝑝𝑟𝑖𝑐𝑒 −𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑝𝑟𝑖𝑐𝑒 + 𝐶𝑎𝑠ℎ 𝑖𝑛𝑓𝑙𝑜𝑤𝑠

Single period return =
𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑝𝑟𝑖𝑐𝑒

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Nagendra Marisetty IAPM Exercises

Example calculating 1997-year return, present value is 230, previous value is 218,
here no dividends
230 − 218
So, return of 1997 Rm is = = 5.5
218

Estimation of Stock Deviation

Year Stock Price Return Rs (Rs - 𝑅̅𝑠)
1996 10.90 - -
1997 12.00 10.1 -0.2
1998 13.30 10.8 0.5
1999 14.00 5.3 -5.0
2000 18.00 28.6 18.3
2001 19.90 10.6 0.3
2001 18.10 -9.0 -19.3
2003 19.80 9.4 -0.9
2004 22.50 13.6 3.3
2005 25.50 13.3 3.0
2006 28.00 9.8 -0.5
Rs = 102.5/10 =
10.3
Estimation of Covariance between Stock and Market
(Rm - 𝑅̅𝑚) (Rs - 𝑅̅ 𝑠) (Rm - 𝑅̅ 𝑚)* (Rs - 𝑅̅𝑠)
- - -
-0.1 -0.2 0
2.2 0.5 1.10
-4.8 -5.0 24.00
7.2 18.3 132.0
-0.3 0.3 0
-8.6 -19.3 166.0
-4.9 -0.9 4.41
4.7 3.3 16.0
5.7 3.0 17.1
-1.4 -0.5 1.2
361

∑𝑛 ̅ ̅
𝑖=1(Rmi − 𝑅 𝑚)∗ (Rsi − 𝑅 𝑠) 361
Covariance of Stock & Market = = = 36.1
𝑛 10
∑𝑛 ̅ ̅
𝑖=1(Rmi – 𝑅 𝑚)∗ (Rsi – 𝑅 𝑠) Covariance of stock and market
β= 𝑛 ̅̅̅̅̅̅
∑𝑖=1(𝑅𝑚𝑖 −𝑅𝑚) 2
=
Variance of market
36.1
= = 1.38
26

Conclusion is XYZ Ltd stock is more volatile than Market.

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Nagendra Marisetty IAPM Exercises

Regression Method
Exercise2: The fallowing historical rate of return information is provided for
Funky Software Co. and the stock market

Year TCS (Stock) (%) Market (%)

2015 12 15
2016 9 13
2017 -11 14
2018 8 -9
2019 11 12
2020 4 9

What is the stock beta by using regression method?

If market return moves 12%, what would be stock return
Solution:
Regression equation stock (y) on market (x) Y = a + bX
𝑛 ∑ 𝑋𝑌 − (∑ 𝑋) (∑ 𝑌)
b= 2
𝑛 𝛴 𝑋 2 − (∑ 𝑋)

Year Stock (%) Y Market (%) X X2 XY

2015 12 15 225 180
2016 9 13 169 117
2017 -11 14 196 -154
2018 8 -9 81 -72
2019 11 12 144 132
2020 4 9 81 36
Total 33 54 896 239

33 54
Stock mean 𝑌̅ = = 5.5%, Market mean 𝑋̅ = = 9%
6 6
𝑛 ∑ 𝑋𝑌 − (∑ 𝑋) (∑ 𝑌) 6 ∗ 239 − 54 ∗33 1434 − 1782
Beta (Slope) β = 2 2 = =
𝑛 𝛴 𝑋 − (∑ 𝑋) 6 ∗ 896 − (54)2 5376 − 2916

−348
= = - 0.1414
2460

Alpha (Intercept) α = 𝑌̅ - β 𝑋̅ = 5.5 – (-0.1414*9) = 5.5 + 1.27 = 6.77

Expected stock Return Y = a + bX = 6.77 + (-0.1414) * 12
= 6.77 – 1.69 = 5.07%

Page 26 of 51
Nagendra Marisetty IAPM Exercises

Expected Beta
Calculate the beta factor for the fallowing investments

Probability p Return on Market r m Return on Stock

10 9 12
20 12 14
30 14 15
40 18 16

Solution:
“When the problem is in probability should not take a Number of
observations (n) to calculate values”
First need to calculate Deviation and variance of the Market
Probability rm P * rm r m - rm (r m - rm ) 2 P*(r m - rm ) 2
10 9 0.9 -5.7 32.49 3.25
20 12 2.4 -2.7 7.29 1.46
30 14 4.2 -0.7 0.49 0.15
40 18 7.2 3.3 10.89 4.36
rm =14.7 σ m =9.22
2

Second need to calculate deviation of the Stock

Probability rs P* r s r s - rs
10 12 1.2 -2.9
20 14 2.8 -0.9
30 15 4.5 0.1
40 16 6.4 1.1
rs =14.9

Finally need to calculate Covariance of market and stock

Probability r m - rm r s - rs (r m - rm )*(r s - rs )  P* (r m - rm )*(r s -
rs )
10 -5.7 -2.9 16.53 1.65
20 -2.7 -0.9 2.43 0.48
30 -0.7 0.1 -0.07 -0.02
40 3.3 1.1 3.63 1.45
Cov m,s =3.56

Now to substitute the values in the equation β =  p * (r

s − rs )(rm − rm )
 2m
3.56
Beta β = = 0.39, Stock is less volatile than the Market
9.22

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Nagendra Marisetty IAPM Exercises

Correlation
Karl Pearson’s Coefficient of Correlation Method
Karl Pearson’s Coefficient of Correlation Measures the degree of association
(relationship) between two variables x and y. For a set of n pairs of values of x
and y,
Pearson’s Coefficient of Correlation, r, is given by
𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 (𝑥, 𝑦) 𝐶𝑜𝑣 (𝑥, 𝑦)
r= =
√𝑉𝑎𝑟 𝑥∗ √𝑉𝑎𝑟 𝑦 𝜎𝑥 𝜎𝑦

1
Covariance = CoV (x, y) = ∑𝑛𝑖=1(𝑥 − 𝑥̅ ) (𝑦 − 𝑦̅ )
𝑛

(𝑥 − 𝑥̅ ) = Difference between x observation and mean of x

(𝑦 − 𝑦 ) = Difference between y observation and mean of y
2 2
∑( 𝑥 − 𝑥̅ )2 𝑛 ∑ 𝑥 2 − (∑ 𝑥) ∑( 𝑦 − 𝑦̅ )2 𝑛 ∑ 𝑦 2 − (∑ 𝑦)
𝜎𝑥 = √ =√ , 𝜎𝑦 = √ =√
𝑛 𝑛2 𝑛 𝑛2

1
∑𝑛
𝑖=1(𝑥− 𝑥̅ ) (𝑦− 𝑦
̅) 𝑛 ∑ 𝑥 𝑦 − (∑ 𝑥) (∑ 𝑦)
𝑛
We have r = 2 2
=
√∑( 𝑥 − 𝑥̅ ) √∑( 𝑦 − 𝑦̅ ) √𝑛 ∑ 𝑥 2 −(∑ 𝑥)2 √𝑛 ∑ 𝑦 2 −(∑ 𝑦)2
𝑛 𝑛

Page 28 of 51
Nagendra Marisetty IAPM Exercises

Problem: From following Index X and stock Y returns calculate correlation

coefficient between X and Y, standard deviation of X & Y, slope and intercept
between X and Y.

Period Index X (%) Stock Y (%)

1 10 4
2 8 8
3 7 -2
4 -6 4
5 12 9
6 15 13
7 20 17
8 14 11
Total 80 64

Solution:

Period Index X (%) Stock Y (%) X2 Y2 XY

1 10 4 100 16 40
2 8 8 64 64 64
3 7 -2 49 4 -14
4 -6 4 36 16 -24
5 12 9 144 81 108
6 15 13 225 169 195
7 20 17 400 289 340
8 14 11 196 121 154
Total 80 64 1214 760 863

80 64
Mean of X = = 10%, Mean of Y = =8
8 8

𝑛 ∑ 𝑥 𝑦 − (∑ 𝑥) (∑ 𝑦)
Correlation = r =
√𝑛 ∑ 𝑥 2 −(∑ 𝑥)2 √𝑛 ∑ 𝑦 2 −(∑ 𝑦)2

8 ∗ 863 − 80 ∗ 64 6904 − 5120

= =
√8 ∗ 1214 − (80)2 √8 ∗760 − (64)2 √9712 − 6400 √6080 − 4096

1784 1784 1784

= = = = 0.696
√3312 √1984 57.54 ∗ 44.54 2563

𝑛∑𝑥 2 − (∑ 𝑥)2 8 ∗ 1214 − (80)2 3312

SD of Index X = √ =√ =√ = √51.75 = 7.19
𝑛2 82 64

Page 29 of 51
Nagendra Marisetty IAPM Exercises

𝑛∑𝑦 2 − (∑ 𝑦)2 8 ∗760 − (64)2 1984

SD of Stock Y = √ =√ =√ = √31 = 5.56
𝑛2 82 64

Covariance between X, Y = Correlation of X & Y * SD of X * SD of Y

= r 𝜎𝑋 𝜎𝑌
= 0.696 * 7.19 * 5.56 = 27.82
Covariance of stock and market 27.82
Slope of Beta between X and Y = = = 0.537
Variance of market 51.75

Intercept or Alpha α = 𝑌̅ - β 𝑋̅ = 8 – 0.537 * 10 = 8 – 5.37 = 2.63

Page 30 of 51
Nagendra Marisetty IAPM Exercises

Problem1: The risk and return of the two securities are shown below
X Y
Expected Return 12% 20%
Risk 3% 7%
An investor plans to invest 80% of its available funds in security X and 20% in
Y. The correlation coefficient between the returns of the portfolio is +1. Find out
the risk and return of the portfolio of X and Y?

Solution:
The expected return of the portfolio is:
Investment Expected Return Proportion Weighted Return
X 12% 0.80 9.6
Y 20% 0.20 4.0
Total =13.6

The risk of the portfolio is  p 2 = wx 2 x 2 + w y 2 y 2 + 2wx w y rxy x y

 p 2 = 0.80 2 * 3 2 + 0.20 2 * 7 2 + 2 * 0.80 * 0.20 *1 * 3 * 7

= 14.44
 p = 3.8
So, the risk and return of the portfolio are 3.8 and 13.6 respectively.

Problem2: Calculate expected return and standard deviation of the investment’s

‘A’ and ‘B’. What will be the risk & return if total investment is divided one half
in each?

Economic Probability P Returns from R A Returns from R B

Climate % %
Dull 0.2 10 6
Stable 0.5 14 15
Growth 0.3 20 11
Also calculate the covariance and correlation?
Solution:
Investment ‘A’ Standard Deviation:
EC P RA% P * R A R A - R A (R A - R A ) P*(R A - R A )
2 2

Dull 0.2 10 2 -5 25 5
Stable 0.5 14 7 -1 1 0.5
Growth 0.3 20 6 5 25 7.5
Total R A =15 Total =13
Variance of return A is 13 and the Standard Deviation is  A = 13 = 3.6%

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Nagendra Marisetty IAPM Exercises

Investment ‘B’ Standard Deviation:

EC P RB % P * RB R B - RB (R B - R B ) P*(R B - R B )
2 2

Dull 0.2 6 1.2 -6 36 7.2

Stable 0.5 15 7.5 3 9 4.5
Growth 0.3 11 3.3 -1 1 0.3
Total R B =12 Total =12

Variance of return B is 12 and the Standard Deviation is  B = 12 = 3.46

Covariance and correlation of the portfolio can be found as fallows

EC P R A - RA R B - RB P*(R A - R A )*(R B - R B )
Dull 0.2 -5 -6 6.0
Stable 0.5 -1 3 -1.5
Growth 0.3 5 -1 -1.5
Total=3.00

So, the covariance (A, B) is 3

Co var iance( A, B )
Correlation between A & B is r AB =
 A B
3.0
= = 0.24
3.6 * 3.46
Portfolio weight A = 0.50, Weight B = 0.50,
r = 0.24, R A =15, R B =12,  A = 3.6,  B = 3.46

Portfolio Return ̅̅̅

𝑅𝑝̅ = ∑ 𝑤𝑖 𝑅𝑖 = 0.50 * 15 + 0.50 * 12 = 13.5%

The risk of the portfolio is  p 2 = wx 2 x 2 + w y 2 y 2 + 2wx w y rxy x y

 p 2 = 0.502 * 3.62 + 0.502 * 3.462 + 2 *0.50*0.50*0.24*3.6*3.46

= 3.34 + 3.00 + 1.494 = 7.834

 p = 2.79

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Problem3: Two securities A and B have the fallowing risk, return and correlation

R A =22, R B =20,  A =10,  B =12 and r AB =0.5

Determine the minimum risk portfolio for A and B?

Solution: In this problem to find out risk, we require weightage of A & B in the
portfolio.

To calculate weightage, require covariance between A and B

Formula for to calculate CoV AB = rAB A  B

= 0.5 * 10 * 12 = 60

 y 2 − cov xy
Formula for to calculate Weightage wx =
 x 2 +  y 2 − 2 cov xy

− 60
2
12
wA =
+ 12 − 2 * 60
2 2
10

144 − 60 84
= = = 0.68
100 + 144 − 120 124

wB = 1 − wB = 1- 0.68 = 0.32

A and B weightage in the portfolio is w A = 68%, wB = 32%

Now need to find out Portfolio Risk

Formula for portfolio risk  p 2 = wx 2 x 2 + w y 2 y 2 + 2wx w y rxy x y

 p 2 = 0.68 2 *10 2 + 0.32 2 *12 2 + 2 * 0.68 * 0.32 * 0.50 *10 *12

= 46.24 + 14.75 + 26.12 = 87.11
Risk  p = 9.33

Formula for portfolio Return = w A * R A + wB * RB

= 0.68 * 22 + 0.32 * 20 = 14.96 + 6.4
= 21.36

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Problem4: An investor has constructed a portfolio consisting of equal amounts

of securities A, B and C. The expected returns and the standard deviation of these
securities are
Security Expected Return Standard Deviation
A 25% 30%
B 22% 26%
C 20% 24%
Correlation coefficients between AB, BC and AC are -0.5, 0.4 and 0.6
respectively. Find out the risk and return of the portfolio.

Solution:
Portfolio Return = 0.33*25 + 0.33*22 + 0.33*20
= 22.33%

Variance of the three stocks portfolio is

 p2 =
wx  x + w y  y + wz  z + 2wx w y rxy x y + 2w y wz ryz y z + 2wz wx rzx z x
2 2 2 2 2 2

=
0.33 * 30 + 0.33 2 * 26 2 + 0.33 * 24 + 2 * 0.33 * 0.33 * −0.5 * 30 * 26 + 2 * 0.33 * 0.33 * 0.4 * 26 * 24
2 2 2 2

+ 2 * 0.33 * 0.33 * 0.6 * 24 * 30

= 100 + 75.11 + 64 – 86.67 + 55.47 + 96
= 303.91
 p = 17.43%

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Nagendra Marisetty IAPM Exercises

UNIT – IV PORTFOLIO SELECTION, REVISION & EVALUATION

Single Index Model
Problem: From the following details of four securities calculate portfolio return
and portfolio risk.
Security Weightage wi Alpha αi Beta βi Residual variances σei2
A 0.2 2.00 1.7 370
B 0.1 3.50 0.5 240
C 0.4 1.50 0.7 410
D 0.3 0.75 1.3 285
(Market return is 15% and market variance is 320)
Solution:
Portfolio Alpha αp = ∑𝑛𝑖=1 𝑤𝑖 𝛼𝑖
= 0.2 x 2.0 + 0.1 x 3.5 + 0.4 x 1.5 + 0.3 x 0.75
= 1.575
Portfolio Beta βp = ∑𝑛𝑖=1 𝑤𝑖 𝛽𝑖
= 0.2 x 1.7 + 0.1 x 0.5 + 0.4 x 0.7 + 0.3 x 1.3
= 1.06
Portfolio residual variances σep2 = ∑𝑛𝑖=1 𝑤𝑖2 𝜎𝑒𝑖
2

= 0.22 x 370 + 0.12 x 240 + 0.42 x 410 + 0.32 x 285

= 108.45
Portfolio return Rp = αp + Rm βp
= 1.575 + 15 x 1.06 = 17.475%
Portfolio variance σp2 = σm2 βp2 + ∑𝑛𝑖=1 𝑤𝑖2 𝜎𝑒𝑖
2

= 1.062 x 320 + 108.45 = 468

Portfolio risk σp = √468 = 21.64

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Problem: The data for three stocks are given. The data are obtained from
correlating returns on these stocks with the returns on the market index.
Stock Alpha αi Beta βi Residual variances σei2
1 -2.1 1.6 14
2 1.8 0.4 8
3 1.2 1.3 18
Which single stock would an investor prefer to own from a risk-return view point
if the market index were expected to have a return of 15% and variance of return
of 20%? (Use single index model)
Solution: Here we have to calculate the expected return and risk of each security
using the single index model.
Market variance σm2 = 20%, Market return Rm = 15%
Expected return of stock Rs = αs + Rm βs
Stock 1 = -2.1 + 15 * 1.6 = -2.1 + 24 = 21.9
Stock 2 = 1.8 + 15 * 0.4 = 1.8 + 6 = 7.8
Stock 3 = 1.2 + 15 * 1.3 = 1.2 + 19.5 = 20.7
Security variance is σs2 = σm2 βs2 + σe2
Stock 1 = 20 x (1.6)2 + 14 = 51.2 + 14 = 65.2
Stock 2 = 20 x 0.42 + 8 = 3.2 + 8 = 11.2
Stock 3 = 20 x 1.32 + 18 = 33.8 + 18 = 51.8
Stock risk is square root of stock variance
Stock 1 σs = √65.2 = 8.07; stock 2 σs = √11.2 = 3.35; stock 3 σs = √20.7 = 4.55;
Now we calculate the ratio of return to risk ratio the return per unit of risk
Table: Return to risk
Stock Return Risk Return to risk Ranking
1 21.9 8.07 2.7138 2
2 7.8 3.35 2.3284 3
3 20.7 4.55 4.5495 1

Stock 3 would generate more return one unit of risk

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Nagendra Marisetty IAPM Exercises

Arbitrage Pricing Theory (APT)

Exercise: Consider the following data for two risk securities (M and N)
λ0 = 8%, λ1 = 4.5%, λ2 = 8.2%; bM1 = 0.76, bM2 = 1.90, bN1 = 1.72, bN2 = 2.45
Security M is currently priced at Rs. 225, Security N is currently priced at 150. Anticipated
prices of the securities at the year end are Rs. 275 and Rs. 175 respectively.
a. Compute expected return of both securities
b. What is the expected price of each security one year from now?
c. Evaluate whether the securities are correctly priced.
Solution:
a. Expected return of a security can be calculated by using APT formula
E(R) = λ0 + b1 λ1 + b2 λ2 + ……. + bn λn,
Here, λ is risk premium i.e., (δ – Rf), δ is the expected return on stock when it has
unit sensitivity to risk factor, b is sensitivity of stock to respective risk factor.
Security M expected return = 8 + 0.76 x 4.5 + 1.90 x 8.2 = 8 + 3.42 + 6.08 = 17.5%
Security N expected return = 8 + 1.72 x 4.5 + 2.45 x 8.2 = 8 + 7.74 + 7.84 = 23.5%
b. Expected price of security after one year can be calculated based on the expected return
Future price = Current price (1 + Discount factor), here discount factor is expected
return of the respective stock or portfolio.
Security M: 225 (1 + 0.175) = 264.38
Security N: 150 (1 + 0.235) = 185.37
c. Evaluation of pricing can be done by comparing expected price based on risk factors and
using APT model and the actual anticipated year end price.
Security M
expected price (theoretical price or calculated future price) is 264.38
Anticipated actual price is 275
As actual price is expected to exceed the theoretical price, the security is attractive; it is
currently under-priced.
Security N
expected price (theoretical price or calculated future price) is 185.37
Anticipated actual price is 175

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As actual price is not expected to move up to the theoretical price, the security is not attractive;
it is currently over-priced.
Exercise: Consider the following data regarding three risk factors and three securities (X, Y
and Z)
Factor loadings
Security F1 F2 F3
X 1.12 -0.56 0.63
Y 0.85 0.74 0.47
Z 1.30 -0.24 1.23
Risk premium associated with the risk factors are
Λ1 = 4.75%, λ2 = 2.30%, λ3 = -1.7%
Current market price and the anticipated future price of the three securities are
Security Current price Future price
X 410 430
Y 145 175
Z 570 620
a. Compute the expected return of the three securities, assuming risk free return 5.5%
b. Evaluate whether the securities are correctly priced.
Solution:
a. Expected security returns as per APT
E(R) = λ0 + b1 λ1 + b2 λ2 + b3 λ3,
Security X = 5.5 + 1.12 x 4,75 + (-0.56) x (2.30) + 0.63 (-1.7)
= 5.5 + 5.32 - 1.29 – 1.07 = 8.46%
Security Y = 5.5 + 0.85 x 4,75 + (0.74) x (2.30) + 0.47 (-1.7)
= 5.5 + 4.04 + 1.70 – 0.87 = 10.44%
Security Z = 5.5 + 1.30 x 4,75 + (-0.24) x (2.30) + 1.23 (-1.7)
= 5.5 + 6.18 – 0.55 – 2.09 = 9.04%
b. Evaluation of security pricing is done by comparing the current market price of the security
with the present value of future cash flows discounted at the APT expected return
Particulars X Y Z
Future cash flow (Sale proceeds of security) 430 175 620
Discount rate (APT expected return) 8.36% 10.44% 9.04%
Present value of future cash flow 396 158 569
Current market price of security 410 145 570
Pricing status Overpriced Under-priced Correctly priced

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Nagendra Marisetty IAPM Exercises

CAPM
Formula for to calculate portfolio return is
Security Market Line (SML) is the graphical form of CAPM
Expected return of the Portfolio 𝑅𝑝 = 𝐼𝑟𝑓 + (𝑅𝑚 − 𝐼𝑟𝑓 ) ∗ 𝛽

𝐼𝑟𝑓 = Risk free return, 𝑅𝑚 = Market return, 𝛽 = Beta.

Problem1: Fallowing information is provided in respect of a security

𝐼𝑟𝑓 = Risk free return=8%, 𝑅𝑚 = Market return=16%, 𝛽 = Beta=0.7; find out the
expected return of the security and if the security has an expect return of 24%,
what must be its Beta?

Sol:
Expected return of the security is 𝑅𝑠 = 𝐼𝑟𝑓 + (𝑅𝑚 − 𝐼𝑟𝑓 ) ∗ 𝛽
= 8 + (16 - 8) * 0.7
= 13.6%

The Beta of the security is

Given Values 𝑅𝑠 = 24, 𝑅𝑚 = 16, 𝐼𝑟𝑓 = 8 and 𝛽 =?

Substitute the values in the above equation

24 = 8 + (16 - 8) * 𝛽
24 = 8 + 8 * 𝛽
24 – 8 = 8 * 𝛽
16 = 8 * 𝛽
𝛽 = 16/8 = 2

Problem2: A security has a standard deviation of 2.8%. The correlation

coefficient of the security with the market is 0.8 and market standard deviation is
2.3%, the return from government securities is 12% and from the market portfolio
is 18%. What is required return on the portfolio?

Sol:
The required rate of return on the portfolio may be found with the help of
CAPM, for which Beta need to find.

Given Values
Market return= 𝑅𝑚 = 18, Risk free return = 𝐼𝑟𝑓 = 12, 𝛽 =?
Correlation coefficient 𝑟𝑠𝑚 = 0.8
Stock standard deviation = 𝜎𝑠 = 2.8% and Market standard deviation = 𝜎𝑚 = 2.3%
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Nagendra Marisetty IAPM Exercises

𝑟𝑠𝑚 ∗𝜎𝑠
Formula to calculate Beta is 𝛽 =
𝜎𝑚
0.8∗2.8
= = 0.974
2.3

Now return on the portfolio is 𝑅𝑝 = 𝐼𝑟𝑓 + (𝑅𝑚 − 𝐼𝑟𝑓 ) ∗ 𝛽

= 12 + (16 - 12) * 0.974
= 17.84%

Problem3: The standard deviation of market return is 40% and expected return
is 14%. The risk free rate of interest is 7%. The covariance of returns for the
market and returns on shares of Sam Ltd. over the same period has been 20%.
Calculate cost of equity (expected rate of return) for Sam ltd.

Sol:
Given values
Market standard deviation = 𝜎𝑚 = 40%
Risk free return = 𝐼𝑟𝑓 = 7%
Market return= 𝑅𝑚 = 14%
Covariance of returns for the market and stock Cov 𝑀, 𝑆 = 20%
𝛽 =? and cost of equity (expected rate of return) is 𝑅𝑝 = ?

Cov M,S
Formula to calculate Beat is 𝛽 =
𝜎2𝑚
Market variance is square of market standard deviation is 0.40^2 = 0.16
0.20
𝛽= = 1.25
0.16

Cost of equity (expected rate of return) is 𝑅𝑝 = 𝐼𝑟𝑓 + (𝑅𝑚 − 𝐼𝑟𝑓 ) ∗ 𝛽

= 7 + (14 - 7) * 1.25
= 7 + 7 * 1.25
= 15.75%

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Problem4: XYZ Ltd has investment in 3 companies A, B, and C. Fallowing

information is available in respect of these investments
Company Investment 𝛽

A 6,00,000 1.3
B 3,00.000 1.4
C 1,00,000 0.9
Expected return on the market portfolio is 15% and the risk free rate of return is
6%, find out the expected 𝛽 and return of the portfolio?

Sol:
The expected return of the portfolio is the weighted average of expected return of
individual investments. On the basis of CAPM, expected 𝛽 of the portfolio is a
fallow

Company Amount Weight(W) 𝛽 W*𝛽

A 6,00,000 6,00,000 1.3 0.6*1.3=0.78
=0.6
10,00,000
3,00,000
B 3,00,000 =0.3 1.4 0.3*1.4=0.42
10,00,000
1,00,000
=0.1
C 1,00,000 10,00,000 0.9 0.1*0.9=0.09

Total=10,00,000 Expected Beta 𝛽 = 1.29

Expected ret urn of the portfolio 𝑅𝑝 = 𝐼𝑟𝑓 + (𝑅𝑚 − 𝐼𝑟𝑓 ) ∗ 𝛽

= 6 + (15 - 6) * 1.29
= 6 + 9 * 1.29
= 6 + 11.61 = 17.61%

Problem5: Fallowing information is available in respect of certain securities

Security 𝛽 Expected Return
I 1.4 22%
II 1.2 16%
III 1.1 14%
The market return is 16% and the risk-free rate is 6%. Find out whether these
securities are correctly priced or not?

Sol:

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Whether these securities are correctly priced or not can be found by

comparing the expected return of the security with the CAPM return. The CAPM
return of these securities
Expected return of the security is 𝑅𝑠 = 𝐼𝑟𝑓 + (𝑅𝑚 − 𝐼𝑟𝑓 ) ∗ 𝛽

For security I = 6 + (16 - 6) * 1.4

= 6 + 10 * 1.4 = 20%

For Security II = 6 + (16 - 6) * 1.2

= 6 + 10 * 1.2 = 18%

For security III = 6 + (16 - 6) * 1.1

= 6 + 10 * 1.1 = 17%

Now need to find out securities correctly priced or not, for that need to calculate
𝛼 values.
𝛼 = Expected Return – CAPM based return

For security I, expected return is 22% and CAPM return is 20%

𝛼 = 22 – 20 = 2
For security II, expected return is 16% and CAPM return is 18%
𝛼 = 16 – 18 = -2
For security III, expected return is 14% and CAPM return is 17%
𝛼 = 14 – 17 = -3

“If 𝜶 value is positive then that stock is under-priced, 𝜶 value is negative that
stock is overpriced. Under priced stocks are good for investment and over
priced stocks not good for investment”

So, from above problem Security I is under-priced and Security II, III are
overpriced.

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Nagendra Marisetty IAPM Exercises

Exercise: The following data are available to you as portfolio manager

Security Estimated return (%) Beta
A 30 1.6
B 24 1.4
C 18 1.2
D 13 0.9
E 17 1.1
F 15 0.7

The risk-free rate of return is 8%, while the market return is expected to be 18%.
In terms of the securities market line, which of the securities listed above or below
of the SML?

Solution:
CAPM Return 𝑅𝑝 = 𝑅𝑓 + (𝑅𝑚 − 𝑅𝑓 ) ∗ 𝛽

Risk-free rate of return 𝑅𝑓 = 8% and Expected market return 𝑅𝑚 = 18

Expected returns of the securities

Security A = 8 + (18 - 8) *1.6 = 8 + 10.6 = 18.6%
Security B = 8 + (18 - 8) *1.4 = 8 + 10.4 = 18.4%
Security C = 8 + (18 - 8) *1.2 = 8 + 10.2 = 18.2%
Security D = 8 + (18 - 8) *0.9 = 8 + 9 = 17.0%
Security E = 8 + (18 - 8) *1.1 = 8 + 11 = 19.0%
Security F = 8 + (18 - 8) *0.7 = 8 + 7 = 15.0%

Table: Comparison of estimated price and expected price (CAPM return)

Estimated Expected
α = ER -
Securities return (%) Return (%) Result Decision
CAPM
ER CAPM
A 30 18.6 11.4 Under priced Good for Investment
B 24 18.4 5.6 Under priced Good for Investment
C 18 18.2 -0.2 Over Priced Bad for Investment
D 13 17 -4 Over Priced Bad for Investment
E 17 19 -2 Over Priced Bad for Investment
F 15 15 0 Fairly Priced No Decision

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Exercise: The following table gives an analyst’s expected return on two stocks for particular
market returns
Market return (%) Aggressive return (%) Defensive return (%)
6 2 8
20 30 16
a. What are the betas of the two stocks
b. What is the expected return on each stock if the market return is equally likely to be 6% or
20%?
c. If the risk-free rate is 7% and the market return is equally likely to be 6% or 20% what is
the SML?
d. What are the alphas of the two stocks?

Solution:
a. The betas of the two stocks
𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑜𝑓 𝑠𝑡𝑜𝑐𝑘 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 30 − 2 28
Aggressive stock = 𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑚𝑎𝑟𝑘𝑒𝑡 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 = 20 − 6 = 14 = 2
16 − 8 8
Defensive stock = = 14 = 0.571
20 − 6

b. The expected returns of the two stocks and market are

Equally like means investing 50% in one situation and another 50% in another
situation.

Aggressive stock expected return = 0.5 * 2 + 0.5 * 30 = 1 + 15 = 16%

Defensive stock = 0.5 * 8 + 0.5 * 16 = 4 + 8 = 12%
Market expected return = 0.5 * 6 + 0.5 * 20 = 3 + 10 = 13%

c. SML line SML = Rf + (Rm – Rf) β

Here, Risk-free rate is 7% and Market expected return Rm = 13%

SML = 7 + (13 – 7) β = 7 + 6 β

d. The alphas of the two stocks are calculated below

Aggressive stock
Market expected return Rm = 13%, Risk-free rate Rf = 7%, Beta β = 2
CAPM return = Rf + (Rm – Rf) β = 7 + (13 – 7) x 2 = 19%
Alpha = Expected return – CAPM return = 16 – 19 = -3%

Defensive stock
Market expected return Rm = 13%, Risk-free rate Rf = 7%, Beta β = 0.571
CAPM return = Rf + (Rm – Rf) β = 7 + (13 – 7) x 0.571 = 10.426%
Alpha = Expected return – CAPM return = 12 – 10.426 = 1.574%

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Nagendra Marisetty IAPM Exercises

CAPM & CML

Exercise: The following data are available to you as portfolio manager
Portfolios Estimated return (%) Beta Standard deviation (%)
A 30 2.0 50
B 25 1.5 40
C 20 1.0 30
D 11.5 0.8 25
E 10 0.5 20
Market Index 15 1.0 18
Govt Security 7 0.0 00
a. Calculate CAPM returns and CML returns for each portfolio
b. In terms of the security market line, which of the portfolios listed above or below of the
SML?
c. Assuming that a new portfolio is constructed using equal proportions of the five portfolios
listed above, calculate the expected return and risk of new portfolio.
Solution:
a. CAPM Returns
CAPM Return 𝑅𝑝 = 𝑅𝑓 + (𝑅𝑚 − 𝑅𝑓 ) ∗ 𝛽
Expected returns of the portfolios
Portfolio A = 7 + (15 - 7) *2.0 = 7 + 16 = 23%
Portfolio B = 7 + (15 - 7) *1.5 = 7 + 12 = 19%
Portfolio C = 7 + (15 - 7) *1.0 = 7 + 8 = 15%
Portfolio D = 7 + (15 - 7) *0.8 = 7 + 6.4 = 13.4%
Portfolio E = 7 + (15 - 7) *0.5 = 7 + 4 = 11%

CML Returns
(𝑅𝑚 − 𝑅𝑓 ) 𝜎𝑝
CML = Rf + ,
𝜎𝑚
Rf = Risk-free return, Rm = Market expected return, σp = Standard deviation of portfolio
σm = Standard deviation of market

Portfolio A = 7 + (15 - 7) *50/18 = 7 + 8*2.78 = 7 + 22.23 = 29.23%

Portfolio B = 7 + (15 - 7) *40/18 = 7 + 8*2.23 = 7 + 17.78 = 24.78%
Portfolio C = 7 + (15 - 7) *30/18 = 7 + 8*1.67 = 7 + 13.34 = 20.34%
Portfolio D = 7 + (15 - 7) *25/18 = 7 + 8*1.38 = 7 + 11.12 = 18.12%
Portfolio E = 7 + (15 - 7) *20/18 = 7 + 8*1.12 = 7 + 8.89 = 15.89%
Table: CAPM & CML returns
Portfolios CAPM returns (%) CML returns (%)
A 23 29.23
B 19 24.78
C 15 20.34
D 13.4 18.12
E 11 15.89

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b. In terms of SML
Table: Comparison of estimated price and expected price (CAPM return)
Expected
Estimated return ER -
Portfolios Return (%) Result Decision
(%) ER CAPM
CAPM
A 30 23 7.0 Under priced Good for Investment
B 25 19 6.0 Under priced Good for Investment
C 20 15 5.0 Under priced Good for Investment
D 11.5 13.4 -1.9 Over Priced Bad for Investment
E 10 11 -1.0 Over Priced Bad for Investment

c.
Expected risk of combination of five portfolios investing equally
βp = ∑𝑛𝑖=1 𝑤𝑖 𝛽𝑖
= 0.2 x 2.0 + 0.2 x 1.5 + 0.2 x 1.0 + 0.2 x 0.8 + 0.2 x 0.5
= 0.2 (2.0 + 1.5 + 1.0 + 0.8 + 0.5) = 0.2 x 5.8 = 1.16
Portfolio expected return = 𝑅𝑓 + (𝑅𝑚 − 𝑅𝑓 ) ∗ 𝛽𝑝
= 7 + (15 – 7) x 1.16 = 7 + 9.28 = 16.28%
So, expected return of new portfolio is 16.28% and risk is 1.16 (Systematic risk)

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Portfolio Evaluation
Portfolio evaluation can be done by using Sharpe, Treynor’s and Jensen α
measure
𝑅𝑝−𝑅𝑓
Formula’s Sharpe =
𝜎

𝑅𝑃 −𝑅𝑓
Treynor’s =
𝛽

Jensen = 𝑅𝑓 + (𝑅𝑚 − 𝑅𝑓 )𝛽,

α measure = Portfolio return – expected return from Jensen measure

Problem1: Fallowing information is available regarding four Mutual funds

Mutual funds Return, R Risk, 𝜎 Beta, β
A 13% 16 0.90
B 17% 23 0.86
C 23% 39 1.26
D 15% 25 1.38
Evaluate performance of these mutual funds using Sharpe, Treynor measure and
Jensen’s measure. Comment on the evaluation after ranking the funds, given that
the risk-free rate is 9% and market return is 12%

Solution:
𝑅𝑝 −𝑅𝑓
i) Using Sharpe measure =
𝜎

Mutual Return Rp Risk free Risk 𝜎 𝑅𝑝 − 𝑅𝑓 𝑅𝑝 − 𝐼𝑟𝑓 Rank

funds rate 𝑅𝑓 𝜎

A 13 9 16 4 0.25 3
B 17 9 23 8 0.348 2
C 23 9 39 14 0.359 1
D 15 9 25 6 0.24 4

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Nagendra Marisetty IAPM Exercises

𝑅𝑝 −𝑅𝑓
ii) Using Treynor measure
𝛽

Mutual Return Rp Risk free 𝛽 𝑅𝑝 − 𝑅𝑓 𝑅𝑝 − 𝑅𝑓 Rank

funds rate 𝑅𝑓 𝛽
A 13 9 0.90 4 4.444 3
B 17 9 0.86 8 9.302 2
C 23 9 1.20 14 11.667 1
D 15 9 1.38 6 4.348 4

iii) Jensen’s Measure

Jensen = 𝑅𝑓 + (𝑅𝑚 − 𝑅𝑓 )𝛽,

α measure = Portfolio return – expected return from Jensen measure

Average Jensen's Jensen

Beta
Mutual Funds return ER Alpha Performance Rank
A 13 0.9 11.700 1.300 OP 4
B 17 0.86 11.580 5.420 OP 2
C 23 1.26 12.780 10.220 OP 1
D 15 1.38 13.140 1.860 OP 3
Market Return 12 1.000

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Nagendra Marisetty IAPM Exercises

Case study: Suppose that seven portfolios experienced the fallowing results
during a ten-year period
Portfolios Average return Standard deviation Correlation with
Market
A 15.6 27 0.81
B 11.8 18 0.55
C 8.3 15.2 0.38
D 19.0 21.2 0.75
E -6.0 4.0 0.45
F 23.5 19.3 0.63
G 12.1 8.2 0.98
Market 13.0 12.0
Treasury bills 6.0

a) Rank these portfolios using

i) Sharpe method and ii) Treynor’s method iii) Jensen α
b) Compare the rankings in part (a) and explain the reasons behind any
Differences noted?
Solution:
First, we have to calculate the Beta between portfolio and market

Covariance of stock and market 𝐶𝑜𝑣 (𝑃, 𝑀)

β= = 2
Variance of market 𝜎𝑚

Cov (P, M) = rpm σp σm

𝑟𝑝𝑚 𝜎𝑝 𝜎𝑚 𝑟𝑝𝑚 𝜎𝑝
β= 2 =
𝜎𝑚 𝜎𝑚

Table: Beta Calculation

Average Standard Correlation with

Portfolios return deviation market Beta
A 15.6 27 0.81 1.823
B 11.8 18 0.55 0.825
C 8.3 15.2 0.38 0.481
D 19 21.2 0.75 1.325
E -6 4 0.45 0.150
F 23.5 19.3 0.63 1.013
G 12.1 8.2 0.98 0.670
Market 13 12
Treasury bills 6

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Nagendra Marisetty IAPM Exercises

Sharpe’s Ratio
𝑅𝑝 −𝑅𝑓
Using Sharpe measure =
𝜎
Table: Sharpe’s Ratio

Average Standard
Portfolios return Rp deviation σ Sharpe ratio Rank
A 15.6 27 0.3556 4
B 11.8 18 0.3222 5
C 8.3 15.2 0.1513 6
D 19 21.2 0.6132 3
E -6 4 -3.0000 7
F 23.5 19.3 0.9067 1
G 12.1 8.2 0.7439 2
Market 13 12 0.5833
Treasury bills 6 Rf

Treynor’s Ratio
𝑅𝑝 −𝑅𝑓
Using Treynor measure
𝛽

Table: Treynor measure

Average
Beta β Treynor's Ratio Rank
Portfolios return Rp
A 15.6 1.823 5.2675 5
B 11.8 0.825 7.0303 4
C 8.3 0.481 4.7784 6
D 19 1.325 9.8113 2
E -6 0.150 -80.0000 7
F 23.5 1.013 17.2712 1
G 12.1 0.670 9.1090 3
Market 13 1.000 7.0000
Treasury bills 6 - Rf

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Nagendra Marisetty IAPM Exercises

Jensen’s Alpha
Jensen Expected return = 𝑅𝑓 + (𝑅𝑚 − 𝑅𝑓 )𝛽,
α measure = Portfolio return – expected return from Jensen measure
Table: Jensen Alpha
Average Jensen's Jensen
Beta β
Portfolios return Rp ER Alpha Performance Rank
A 15.6 1.823 18.758 -3.158 UP 6
B 11.8 0.825 11.775 0.025 OP 4
C 8.3 0.481 9.369 -1.069 UP 5
D 19 1.325 15.275 3.725 OP 2
E -6 0.150 7.050 -13.050 UP 7
F 23.5 1.013 13.093 10.407 OP 1
G 12.1 0.670 10.688 1.412 OP 3
Market 13 - Rm 1.000 13.000 0.000
Treasury bills 6 - Rf

Table: Comparison of three measures

Sharpe Treynor's Jensen
Portfolios ratio Rank Ratio Rank Alpha Performance Rank
A 0.3556 4 5.2675 5 -3.1575 UP 6
B 0.3222 5 7.0303 4 0.0250 OP 4
C 0.1513 6 4.7784 6 -1.0693 UP 5
D 0.6132 3 9.8113 2 3.7250 OP 2
E -3.0000 7 -80.0000 7 -13.0500 UP 7
F 0.9067 1 17.2712 1 10.4073 OP 1
G 0.7439 2 9.1090 3 1.4123 OP 3
Market 0.5833 7.0000 0.0000
Treasury bills

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