Security Analysis and Portfolio Management

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Security Analysis and Portfolio Management

SECTION - A:

Q1 “There is a trade-off between risk and return.” Explain this statement.

Q2 “Stock exchanges act as barometers of the health of the economy.” Discuss.

Q3 What is Beta? How is it interpreted?

Q4 “Fundamental analysis provides an analytical framework for rational investment decision making.’’ Explain.

Q5 Explain the merits and demerits of technical analysis as a tool of security analysis.

SECTION - B:

Q1 “When someone refers to efficient capital markets, they mean that security prices fully reflect all available information.”

Q2 “CAPM postulates the nature of relationship between the expected return and the systematic risk of a security.” Explain.

Q3 “Forward contracts are a part of everyday life.” Explain.

CASE STUDY:

You are given the following historical performance information on the capital market and a mutual fund:

Year	Mutual fund beta	Mutual fund return (per cent)	Return on market index (per cent)	Return on Govt. securities (per cent)
1 2 3 4 5 6 7 8 9 10	0.90 0.95 0.95 1.00 1.00 0.90 0.80 0.75 0.75 0.70	- 3.00 1.50 18.00 22.00 10.00 7.00 18.00 24.00 15.00 - 2.00	- 8.50 4.00 14.00 18.50 5.70 1.20 16.00 18.00 10.00 8.00	6.50 6.50 6.00 6.00 5.75 5.75 6.00 5.50 5.50 6.00

Calculate the following risk adjusted return measures for the mutual fund:

(a) Reward-to-variability ratio or Sharpe ratio

(b) Reward-to-volatility ratio or Treynor ratio

Comment on the mutual fund’s performance.

SECTION - C

Q1. For investment purposes:

(a) Common stock is considered a fixed income security

(b) Preferred stock is considered a fixed income security

(c) Both are considered fixed income securities.

(d) Derivatives is considered fixed income securities

Q2 The scores that have the greatest effect on the value of the variance are those

(a) below the mean

(b) nearest the mean

(c) farthest from the mean

(d) none of the above

Q3 Without violating the rules of CAPM, which of the following strategies may be undertaken in an attempt to earn a return that’s greater than that of the market?

(a) Short sell securities that have a beta of less than one and purchase the market portfolio.

(b) Purchase securities that have a higher standard deviation than that of the market.

(c) Purchase securities whose correlation coefficient with that of the market is greater than one.

(d) All of the above.

Q4 An investor seeking to capitalize on a strong market upswing reduces her money market holdings and greatly increases her holding of stocks. This investor is primarily increasing:

(a) Total risk

(b) Systematic risk

(c) Non market risk

(d) Unsystematic risk

Q5 An investor invests 30 percent of his wealth in a risky asset with an expected rate of return of 15 percent and a variance of 400 and 70 percent in a T-bill that pays 6 percent. His portfolio’s expected return and standard deviation are __________ and _________ respectively.

(a) 8.7%, 12%

(b) 8.7%, 6 %

(c) 11.4% , 6%

(d) 12%, 6%

Q6 Points under capital allocation line are __________ by investors.

(a) desirable but not achievable

(b) achievable but not desirable

(c) both desirable and achievable

(d) neither desirable nor achievable

Q7 Which statement about portfolio diversification is correct?

(a) The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities have been purchased.

(b) Because diversification reduces portfolio’s total risk, it necessarily reduces the portfolio’s expected return.

(c) Typically, as more securities are added to a portfolio, total risk would be expected to decrease (at a decreasing rate).

(d) None of the above.

Q8 Assume risk free-rate is 5%. The expected return on market portfolio is 12%, and its standard deviation is 20%. A company has an expected return of 18%, a standard deviation of 30% and a correlation of 1.5 with the market. What is the company’s Treynor Ratio?

(a) 0.047

(b) 0.058

(c) 0.087

(d) 0.092

Q9 What are the three main criteria used for portfolio analysis?

(a) Balance, attractiveness and fit.

(b) The BCG matrix, the Ashridge Portfolio Display and the Ansoff matrix.

(c) Synergies, geographical spread and diversification.

(d) Spread of risk; range of products; range of services.

Q10 Which of the following best describes the relationship between the nature of diversification of a firm and the financial performance of that firm?

(a) The more unrelated a firm’s portfolio, the higher the financial performance.

(b) The less diversified the portfolio the higher the financial performance.

(c) Related and limitedly diversified companies perform better on average than both undiversified and heavily diversified companies.

(d) There is no relationship.

Q11 Active portfolio management consists of __________.

(a) market timing

(b) security analysis

(c) indexing

(d) A and B

Q12. 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.

(e) is useless if abnormal returns are available.

Q13 Consider these two investment strategies:

Strategy ___ is the dominant strategy because __________.

(a) 1, it is risk less

(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

(e) both strategies are equally preferred.

Q14. Arbitrage is the presence of a

(a) Fixed profit

(b) Risky profit

(c) Riskless profit

(d) Maximizing profit

Q15. Compounding refers to the:

(a) Earning of interest on prospectively earned interest

(b) Earning of interest on previously earned interest

(c) Earning of interest on principal amount

(d) B and C

Q16. The three broad categories of financial assets are ____________.

(a) Money market securities, long-term debt and equity

(b) Corporate securities, derivatives and equity

(c) Debt, equity and derivatives

(d) All of the given options

Q17. Which of the following is excluded from the fixed income securities?

(a) Bonds

(b) Preferred stock

(c) Saving deposits

(d) Options

Q18. Financial securities with a maturity of less than a year from their original issue date

are sold in the:

(a) Money market

(b) Bond market

(c) Equity market

(d) Derivative market

Q19 Which of the following represents low-priced, speculative and risky securities?

(a) Income stocks

(b) Penny stocks

(c) Defensive stocks

(d) Cyclical stocks

Q20 Which of the following is EXCLUDED from Porter’s competitive factors?

(a) Bargaining power of buyers

(b) Rivalry between existing competitors

(c) Substitute products or services

(d) Changes in the economy

Q21 If the standard deviation of stock A is 30%, standard deviation of stock B is 30%

and the correlation between stocks A and B is 0.8, the co-variance between stocks A and B is:

(a) 9%

(b) 7.2%

(c) 6.42%

(d) 10%

Q22 Which of the following statements regarding Efficient frontier are incorrect?

(a) Efficient frontier represents that set of portfolios that provides the maximum rate of return for every given level of risk.

(b) Efficient frontier provides the maximum risk for each level of return.

(c) Points along the efficient frontier dominate all points beneath the curve.

(d) Points along the curve to the right of any other point on the curve must have a higher expected return and higher level of risk.

Q23. Brokerage fee charged by a stockbroker is an example of:

(a) Margin profit

(b) Insurance premium

(c) Transaction cost

(d) Capital expenditure

Q24 A form of the EMH which states that security prices fully reflect all public and private information.

(a) Strong form efficiency

(b) Weak form efficiency

(c) Semi strong form efficiency

(d) None of the given options

Q25 The computation of the Dow Jones Industrial Average is known as a __________ index.

(a) Price-weighted

(b) Market value

(c) Equal-weighted

(d) Volume weighted

Q26. Which of the following is defined as an investment strategy that involves ongoing

buying and selling actions by the investors?

(a) Active strategy

(b) Passive strategy

(c) Buy-and-hold strategy

(d) All of the given options

Q27. In Security Analysis and Portfolio Management beta is the measure of:

(a) Systematic risk

(b) Unsystematic risk

(c) Total risk

(d) Business risk

Q28 Which of the following statement is (are) inconsistent with Markowitz theory of portfolio management?

1. Investors maximize a one-period expected utility curve with inherent diminishing marginal utility of wealth.

2. Investors use the risk measure of beta as the basis of determining risk.

3. Investors base their investment decisions exclusively on the basis of expected risk and return.

4. A single asset of portfolio of assets is considered to be efficient if no available asset has a superior return for a given risk level, or lower risk given a return level.

(a) 1. only

(b) 2. only

(c) 3. only

(d) 3. and 4.

Q29 The Price/Earning ratio valuation method values a company:

(a) on an absolute basis.

(b) relative to other comparable companies based on the ratio of value to earnings.

(c) based on historical earnings

(d) none of the above.

Q30 Young company does not currently pay any dividends. An analyst forecasts that

Young company will pay its first dividend of $0.50 per share at the end of year 5 and that the dividend payout will grow at the rate of 12% per year in perpetuity. If the required rate of return on young company stock is 13%, the current value of its stock will be closest to:

(a) $27.14

(b) $30.67

(c) $50.00

(d) $52.00

Q31. Which of the following statements is (are) valid regarding the interest rate risk for

floating rate securities?

The price of floating- rate security will fluctuate because:

1. The longer the time to the next coupon reset date, the greater the potential price fluctuation.

2. The required margin that investors demand in the market changes.

3. A floating-rate security can have a cap.

(a) 1 only

(b) 1 and 2

(c) 1 and 3

(d) 1,2 and 3

Q32. What is the price of a stock estimated to pay a dividend of $.60 next year, if the

dividend growth rate is 5% and the appropriate discount rate is 8%?

(a) $18

(b) $19

(c) $20

(d) $21

Q33. Which of the following is on the horizontal axis of the Security Market Line?

(a) Standard deviation

(b) Beta

(c) Expected return

(d) Required return

Q34. A call is an option to

(a) sell stock at a specified price.

(b) buy stock at a specified price

(c) sell stock on a specified date

(d) buy stock on a specified date

Q35. If you were confident that the price of stock X would drop dramatically within two

months, which of the following investment transactions would yield the highest return on your investment?

(a) Purchase stock X

(b) Sell stock X short

(c) Purchase a call on stock X

(d) Purchase a put on stock X

Q36 While bond prices fluctuate,

(a) yields are constant

(b) coupons are constant

(c) the spread between yields is constant

(d) short-term bond prices fluctuate even more

Q37. If interest rates rise, the price of preferred stock

(a) is not affected

(b) rises

(c) falls

(d) may rise or fall

Q38. The use of financial leverage by a firm may be measured by the

(a) ratio of debt to total assets

(b) firm’s beta coefficient

(c) firm’s retention of earnings

(d) ratio of the price of the firm’s stock price to its earnings

Q39. Which of the following is defined as the rate of return anticipated on a bond if it is

held until the maturity date?

(a) Discount rate

(b) Interest free rate

(c) Return on equity

(d) Yield to maturity

Q40. A large number of competing investors is necessary for market efficiency because:

1. it creates independent and random price changes.
2. it results in faster price adjustment.
3. information is more fully examined and acted upon.

(a) 1 only

(b) 1 and 2

(c) 2 and 3

(d) 1,2 and 3