Portfolio Management-1

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ASSIGNMENT A

 

1. What are basic assumptions of CAPM? What are the advantages of adopting CAPM model in the portfolio management?

2. State the reason for the Treynor and Sharpe indices of portfolio performance? Which do you recommend and why?

3. “The average cost per share of stocks purchased under rupee cost averaging is lower”. Does this hold good all the time? Explain.

4. Why is it important to understand competitive position of the product of the company in purchasing the shares of the company?

5. How does technical analysis differ from the fundamental analysis?

 

 

 

ASSIGNMENT B

1. Describe Redington’s Immunization theory investment management.

2. How does new information affect the pricing of securities? How is new information related to efficient market theory?

3. Define Markowitz diversification. Explain the statistical method used by Markowitz to obtain the risk reducing benefit?

 

 

 

 

Case Study: Asian Paint

 

Paint industry growht was at a rate of 12% during 1995-96. The industry as a whole will continue its grow at not less than 8- 10% rate in the coming years. Assian Paints is the leader in decorative paints, controlling 45% of market segment of the total of Rs. 1,800 crore paints and varnishes industry. In industrial paints, it is the largest player with a market share of 14%. With a low per capita consumption of paints in our country, it has good future prospects. The prospects for exports are good with an actual export of Rs. 16 crore in 1995-96. The users in industrial sector, namely, automobiles and its accessories, Household appliances and consumer durables etc. are showing prospects of rapid growth Thus, the potential for the industry both in the domestic and export sector is good. Asian Paints which is a leader in this industry has an installed capacity of 1.08 lakh T.P.A. of Paints enamels and varnishes. Its gross block grew from Rs. 123 crores in 1993-94 to Rs. 187 crores in 1995-96, due to continuous expansion of capacity. The sales turnover recorded a compound growth rate of 13.5% p.a. during the last five years, while its net profit grew faster by 27.5% during the same period.

 

This company has many plus factors :

1. Good Collaborator namely, Chemische Werke HHals A.G. Germany for manufacture of Vinyl Pyrdine Latex and PPG Industries Ine. USA, for electro deposition coating on automobiles.

2. Product differentiation and brand image is secured by Assian Paints by spending only 1.5% of revenue on advertiseents to testing the quality, availability and

dependability.

3. Plants well distributed geographically.

4. Six joint collaborations in foreign countries and good export growth.

5. Good stress on R & D for absorption of foreign technologies and their upgradation.

Asian Paints is one of the three winners of the ET – Harward Business School Association of India awards for its performance in 1994-95. The measures used by them are as follows :

 

Financial Ratios of the Company

Gross Profits / Total assets 21.36%

Retained Profits/Net worth 18.24 %

Net Profit / Net Worth 25.96%

Growth in Market Cap / Growth in Net worth (over 5 years)

1.60

Cash flow to gross assets 20.64

 

Questions:

1. Comment over company’s financial position?

2. Prepare fundamental analysis?

3. Explain company’s Growth Prospects?

 

 

ASSIGNEMNT C

 

1. In the Treynor-Black model

A) portfolio weight are sensitive to large alpha values which can lead to infeasible long or short position for many portfolio managers.

B) portfolio weight are not sensitive to large alpha values which can lead to infeasible long or short position for many portfolio managers.

C) portfolio weight are sensitive to large alpha values which can lead to the optimal portfolio for most portfolio managers.

D) portfolio weight are not sensitive to large alpha values which can lead to the optimal portfolio for most portfolio managers.

 

2. Benchmark portfolio risk is defined as

A) the return difference between the portfolio and the benchmark

B) the variance of the return of the benchmark portfolio

C) the variance of the return difference between the portfolio and the benchmark

D) the variance of the return of the actively-managed portfolio

 

3. Benchmark portfolio risk

A) is inevitable and is never a significant issue in practice.

B) is inevitable and is always a significant issue in practice.

C) cannot be constrained to keep a Treynor-Black portfolio within reasonable weights.

D) can be constrained to keep a Treynor-Black portfolio within reasonable weights.

 

4. ____________ can be used to measure forecast quality and guide in the proper adjustment of forecasts.

A) regression analysis

B) exponential smoothing

C) ARIMA

D) moving average models

 

5. Even low-quality forecasts have proven to be valuable because R-squares of only ____________ in regressions of analysts’ forecasts can be used to substantially improve portfolio performance.

A) 0.656

B) 0.452

C) 0.258

D) 0.001

 

6. The ____________ model allows the private views of the portfolio manager to be incorporated with market data in the optimization procedure.

A) Black-Litterman

B) Treynor-Black

C) Treynor-Mazuy

D) Black-Scholes

 

7. The Black-Litterman model and Treynor-Black model are

A) nice in theory but practically useless in modern portfolio management.

B) complementary tools that should be used in portfolio management.

C) contradictory models can not be use together; therefore, portfolio managers must choose which one suits their needs.

D) not useful due to their complexity.

 

8. The Black-Litterman model is geared toward ____________ while the Treynor-Black model is geared toward ____________.

A) security analysis; security analysis

B) asset allocation; asset allocation

C) security analysis; asset allocation

D) asset allocation; security analysis

 

9. Alpha forecasts must be ____________ to account for less-than-perfect forecasting quality. When alpha forecasts are ____________ to account for forecast imprecision, the resulting portfolio position becomes ____________.

A) shrunk, shrunk, far less moderate

B) shrunk, shrunk, far more moderate

C) grossed up, grossed up, far less moderate

D) grossed up, grossed up, far more moderate

 

10. Tracking error is defined as

A) the difference between the returns on the overall risky portfolio versus the benchmark return.

B) the variance of the return of the benchmark portfolio

C) the variance of the return difference between the portfolio and the benchmark

D) the variance of the return of the actively-managed portfolio

 

11. The tracking error of an optimized portfolio can be expressed in terms of the ____________ of the portfolio and thus reveal ____________.

A) return; portfolio performance

B) total risk; portfolio performance

C) beta; portfolio performance

D) beta; benchmark risk

 

12. The Treynor-Black model is a model that shows how an investment manager can use security analysis and statistics to construct __________.

A) a market portfolio

B) a passive portfolio

C) an active portfolio

D) an index portfolio

 

 

13. If a portfolio manager consistently obtains a high Sharpe measure, the manager’s forecasting ability __________.

A) is above average

B) is average

C) is below average

D) does not exist.

 

14. Active portfolio management consists of __________.

A) market timing

B) security analysis

C) indexing

D) A and B

 

15. The critical variable in the determination of the success of the active portfolio is ________.

A) alpha/systematic risk

B) alpha/nonsystematic risk

C) gamma/systematic risk

D) gamma/nonsystematic risk

 

16. In the Treynor-Black model, the weight of each security in the portfolio should be proportional to its __________.

A) alpha/beta

B) alpha/beta/residual variance

C) beta/residual variance

D) alpha/residual variance

 

17. Active portfolio managers try to construct a risky portfolio with __________.

A) a higher Sharpe measure than a passive strategy

B) a lower Sharpe measure than a passive strategy

C) the same Sharpe measure as a passive strategy

D) very few securities

 

18. The beta of an active portfolio is 1.20. The standard deviation of the returns on the market index is 20%. The nonsystematic variance of the active portfolio is 1%. The standard deviation of the returns on the active portfolio is __________.

A) 3.84%

B) 5.84%

C) 19.60%

D) 26.0%

 

19. Consider the Treynor-Black model. The alpha of an active portfolio is 2%. The expected return on the market index is 16%. The variance of return on the market portfolio is 4%. The nonsystematic variance of the active portfolio is 1%. The risk-free rate of return is 8%. The beta of the active portfolio is 1. The optimal proportion to invest in the active portfolio is __________.

A) 0%

B) 25%

C) 50%

D) 100%

 

20. Consider the Treynor-Black model. The alpha of an active portfolio is 1%. The expected return on the market index is 16%. The variance of the return on the market portfolio is 4%. The nonsystematic variance of the active portfolio is 1%. The risk-free rate of return is 8%. The beta of the active portfolio is 1.05. The optimal proportion to invest in the active portfolio is __________.

A) 48.7%

B) 50.0%

C) 51.3%

D) 100.0%

E) none of the above

 

21. There appears to be a role for a theory of active portfolio management because

A) some portfolio managers have produced sequences of abnormal returns that are difficult to label as lucky outcomes.

B) the “noise” in the realized returns is enough to prevent the rejection of the hypothesis that some money managers have outperformed a passive strategy by a statistically small, yet economic, margin.

C) some anomalies in realized returns have been persistent enough to suggest that portfolio managers who identified these anomalies in a timely fashion could have outperformed a passive strategy over prolonged periods.

D) A, B, and C.

 

22. The Treynor-Black model

A) considers both macroeconomic and microeconomic risks.

B) considers security selection only.

C) is relatively easy to implement.

D) A and C.

 

23. To improve future analyst forecasts using the statistical properties of past forecasts, a regression model can be fitted to past forecasts. The intercept of the regression is a __________ coefficient, and the regression beta represents a __________ coefficient.

A) bias, precision

B) bias, bias

C) precision, precision

D) precision, bias

 

24. A purely passive strategy is defined as

A) one that uses only index funds.

B) one that allocates assets in fixed proportions that do not vary with market conditions.

C) one that is mean-variance efficient.

D) both A and B.

25. Consider these two investment strategies:

 

 

Strategy ___ is the dominant strategy because __________.

A) 1, it is riskless

B) 1, it has the highest reward/risk ratio

C) 2, its return is at least equal to Strategy 1 and sometimes greater

D) 2, it has the highest reward/risk ratio

 

26. The Treynor-Black model assumes that

A) the objective of security analysis is to form an active portfolio of a limited number of mispriced securities.

B) the cost of less than full diversification comes from the nonsystematic risk of the mispriced stock.

C) the optimal weight of a mispriced security in the active portfolio is a function of the degree of mispricing, the market sensitivity of the security, and its degree of nonsystematic risk.

D) all of the above are true.

 

27. Consider the Treynor-Black model. The alpha of an active portfolio is 3%. The expected return on the market index is 18%. The standard deviation of the return on the market portfolio is 25%. The nonsystematic standard deviation of the active portfolio is 15%. The risk-free rate of return is 6%. The beta of the active portfolio is 1.2. The optimal proportion to invest in the active portfolio is __________.

A) 50.0%

B) 69.4%

C) 72.3%

D) 80.6%

 

28. According to the Treynor-Black model, the weight of a security in the active portfolio depends on the ratio of __________ to __________.

A) the degree of mispricing; the nonsystematic risk of the security

B) the degree of mispricing; the systematic risk of the security

C) the market sensitivity of the security; the nonsystematic risk of the security

D) the nonsystematic risk of the security; the systematic risk of the security

 

29. One property of a risky portfolio that combines an active portfolio of mispriced securities with a market portfolio is that, when optimized, its squared Sharpe measure increases by the square of the active portfolio’s

A) Sharpe ratio.

B) information ratio.

C) alpha.

D) Treynor measure.

 

30. A purely passive strategy

A) uses only index funds.

B) uses weights that change in response to market conditions.

C) uses only risk-free assets.

D) is best if there is “noise” in realized returns.

 

31. A manager who uses the mean-variance theory to construct an optimal portfolio will satisfy

A) investors with low risk-aversion coefficients.

B) investors with high risk-aversion coefficients.

C) investors with moderate risk-aversion coefficients.

D) all investors, regardless of their level of risk aversion.

 

32. Ideally, clients would like to invest with the portfolio manager who has

A) a moderate personal risk-aversion coefficient.

B) a low personal risk-aversion coefficient.

C) the highest Sharpe measure.

D) the highest record of realized returns.

 

33. An active portfolio manager faces a tradeoff between

I) using the Sharpe measure.

II) using mean-variance analysis.

III) exploiting perceived security mispricings.

IV) holding too much of the risk-free asset.

V) letting a few stocks dominate the portfolio.

 

A) I and II

B) II and V

C) III and V

D) III and IV

 

34. To determine the optimal risky portfolio in the Treynor-Black Model, macroeconomic forecasts are used for the _________ and composite forecasts are used for the __________.

A) passive index portfolio; active portfolio

B) active portfolio, passive index portfolio

C) expected return; standard deviation

D) expected return ; beta coefficient

 

35. The beta of an active portfolio is 1.45. The standard deviation of the returns on the market index is 22%. The nonsystematic variance of the active portfolio is 3%. The standard deviation of the returns on the active portfolio is __________.

A) 36.30%

B) 5.84%

C) 19.60%

D) 24.17%

 

36. Consider the Treynor-Black model. The alpha of an active portfolio is 1%. The expected return on the market index is 11%. The variance of return on the market portfolio is 6%. The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 4%. The beta of the active portfolio is 1.1. The optimal proportion to invest in the active portfolio is __________.

A) 45%

B) 25%

C) 50%

D) 100%

 

37. Consider the Treynor-Black model. The alpha of an active portfolio is 3%. The expected return on the market index is 10%. The variance of the return on the market portfolio is 4%. The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 3%. The beta of the active portfolio is 1.15. The optimal proportion to invest in the active portfolio is __________.

A) 48.7%

B) 98.3%

C) 51.3%

D) 100.0%

 

38. Consider the Treynor-Black model. The alpha of an active portfolio is 2%. The expected return on the market index is 12%. The variance of the return on the market portfolio is 4%. The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 3%. The beta of the active portfolio is 1.15. The optimal proportion to invest in the active portfolio is __________.

A) 48.7%

B) 98.3%

C) 47.6%

D) 100.0%

 

39. Perfect timing ability is equivalent to having __________ on the market portfolio.

A) a call option

B) a futures contract

C) a put option

D) a commodities contract

 

40. Kane, Marcus, and Trippi (1999) show that the annualized fee that investor should be willing to pay for active management, over and above the fee charged by a passive index fund, depends on

I) the investor’s coefficient of risk aversion

II) the value of at-the-money call option on the market portfolio

III) the value of out-of-the-money call option on the market portfolio

IV) the precision of the security analyst

V) the distribution of the squared information ratio of in the universe of securities

 

A) I, II, IV

B) I, III, V

C) II, IV, V

D) I, IV, V