Topic: Portfolio Management

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  • 15 Marks

FM – Nov 2016 – L3 – SC – Q5 – Portfolio Management

Assess CAPM's basic assumptions and determine overvalued securities among four companies using CAPM metrics.

a. Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.
What are the basic assumptions on which this model is based? (6 Marks)

b. Currently, the rate of return on the Federal Government Bond redeemable at par in the year 2018 is 5%. The securities of four companies, Akira Plc., Bombadia Plc., Courage Plc., and Divine Plc., have expected returns of 12%, 9.5%, 10.5%, and 13%, respectively. The average expected return on the market portfolio is 10%, subject to a 6% risk (standard deviation). Other relevant information relating to the four securities of the companies is as stated below:

Company Standard Deviation Correlation Coefficient
Akira Plc 0.080 0.975
Bombadia Plc 0.075 0.640
Courage Plc 0.090 0.740
Divine Plc 0.150 0.680

You are required to show which of the companies is/are overvalued. (9 Marks)

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  • 20 Marks

FM – May 2019 – L3 – Q5 – Portfolio Management

Evaluate whether an option price is fair for hedging Yaro Plc. shares, and explain how changes in volatility and the risk-free rate affect the value of a call option.

You are the portfolio manager of an asset management company based in Kano. Your company has in its portfolio 27,750,000 shares of Yaro Plc., a company listed on the Nigerian Stock Exchange. The shares are currently trading at N3.60 per share.

Your company plans to sell the shares in six months’ time to pay dividends, and you plan to hedge the risk of Yaro’s shares falling by more than 5% from their current market value. A decision has therefore been taken to buy an over-the-counter option to protect the shares. A merchant bank has offered to sell an appropriate six-month option to your company for N1,250,000.

Yaro’s share price has an annual standard deviation of 13%, and the risk-free rate is 4% per year.

Required:

a. Evaluate whether or not the price at which the merchant bank is willing to sell the option is a fair price.

b. Explain briefly (without any calculations) how a decrease in the value of each of the following variables is likely to change the value of a call option:
i. Volatility of the stock price
ii. Risk-free rate

(Total: 15 Marks)

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  • 20 Marks

FM – May 2019 – L3 – Q4 – Portfolio Management

Evaluate abnormal returns for shares and bonds, calculate required returns for a pension fund portfolio, and assess its active management strategy.

The managers of a pension fund follow an active portfolio management strategy. They try to purchase shares and bonds that show a positive abnormal return (positive alpha factor in the case of shares). The pension fund is required by law to hold at least 40% of its investments in bonds. N100million is currently available for
investment. Three shares and three bonds are being considered for purchase. The required return on bonds may be measured using a model similar to the capital asset pricing model, where beta is replaced by the relative duration of the individual bond (Di) and the bond market portfolio (Dm) i.e. Di/Dm.

Note: Assume the risk-free rate is 4 percent per year.

Required:

a. Evaluate whether or not any of the shares or bonds is expected to offer a positive abnormal return. (10 Marks)

b. The pension fund currently has the maximum permitted investment in shares and wishes to continue this strategy. It has a market value of N1,000 million and a beta of 0.62.

Required:
Calculate the required return from the pension fund if any shares and bonds with positive abnormal returns are purchased. State clearly any assumptions that you make. (4 Marks)

c. Discuss possible problems with the pension fund’s investment strategy. (6 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q6 – Portfolio Management

Evaluate Tico Plc’s share price using CAPM, identify potential errors in valuation, and discuss limitations of portfolio theory in physical investment decisions.

Tico Plc is comprised of only four major investment projects, details of which are as follows:

Project % of Company Market Value Annual % Return During Last 5 Years Risk % Standard Deviation Correlation with the Market
1 28 10 15 0.55
2 17 18 20 0.75
3 31 15 14 0.84
4 24 13 18 0.62

The risk-free rate is expected to be 5% per year, the market return 14% per year, and the standard deviation of market returns 13%.

Required:

a. Assume that Tico Plc’s shares are currently priced based upon the assumption that the last five years’ experience of returns will continue for the foreseeable future. Evaluate whether or not the share price of Tico Plc is undervalued or overvalued. (8 Marks)

b. Discuss why your results in (a) above might not correctly identify whether or not the share price of Tico Plc is undervalued or overvalued. (6 Marks)

c. Briefly discuss the key limitations of portfolio theory in the analysis of physical investment decisions in practice. (6 Marks)

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  • 6 Marks

FM – Nov 2016 – L3 – Q5a – Portfolio Management

Explanation of the basic assumptions of the Capital Asset Pricing Model (CAPM).

(a) Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.

What are the basic assumptions on which this model is based?

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  • 15 Marks

FM – Nov 2021 – L3 – Q6 – Portfolio Management

Analyze the risk profile of Bettaluck plc's short-term equity portfolio and assess investment adjustments based on market returns and financial strategy.

Bettaluck plc is experiencing a substantial net cash inflow, which has been temporarily invested in a short-term equity portfolio. This portfolio consists of investments in four Nigerian listed companies. The funds are intended to meet tax obligations, dividend payments, and future capital expenditures in several months.

Portfolio Details:

Required:

a. Based on the data provided, calculate the risk (i.e., Beta) of Bettaluck’s short-term investment portfolio relative to the market. (4 Marks)

b. Recommend whether the composition of Bettaluck’s short-term investment portfolio should be adjusted. Provide reasons for your recommendation, including relevant calculations. (6 Marks)

c. Discuss the factors a financial manager should consider when investing in marketable securities. (5 Marks)

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  • 20 Marks

FM – May 2018 – L3 – SB – Q4 – Portfolio Management

Analyze SF Plc.'s portfolio beta and assess whether the short-term investment strategy is optimal.

Sunmola Funds (SF) Plc. has a portfolio of short-term investments in the shares of four quoted companies.

Company Holding
Tomiwa (T) 100,000 shares
Pascal (P) 155,000 shares
Binta (B) 260,000 shares
Yetunde (Y) 420,000 shares

You have the following additional information:

Company Beta Market Value Per Share (Kobo) Expected Total Return on Investment p.a (%)
T 1.55 280 21.0
P 0.65 340 12.5
B 1.26 150 18.0
Y 1.14 9.5 18.5

The market risk premium is 10% per year, and the risk-free rate is 6% per year.

Required:

a. Estimate the Beta of SF Plc.’s short-term investment portfolio. (4 Marks)

b. Recommend, giving your reasons, whether the composition of SF Plc.’s short-term investment portfolio should be changed using relevant calculations. (10 Marks)
Hint: Consider the alpha values of the shares and the propriety of investing short-term funds in equity.

c. Explain THREE factors that a financial manager should take into account when investing in marketable securities. (6 Marks)

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  • 15 Marks

FM – Nov 2017 – L3 – Q7 – Portfolio Management

Evaluate investment risk in different portfolio scenarios and explain the implications of beta and alpha values for KT Plc’s equity.

a. In the context of the selection and holding of investments, discuss each of the following scenarios:

i. An investor holding only one security needs to be concerned with the unsystematic risk of that security. (3 Marks)

ii. However, an investor who holds a number of securities should take account of total risk. (3 Marks)

iii. An investor should never add to a portfolio an investment that yields a return less than the market rate of return. (3 Marks)

b. The equity beta of KT Plc. is 1.2 and the equity alpha is 1.4. Explain the meaning and significance of these values to the company. (6 Marks)

(Total 15 Marks)

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  • 15 Marks

FM – Nov 2016 – L3 – SC – Q5 – Portfolio Management

Assess CAPM's basic assumptions and determine overvalued securities among four companies using CAPM metrics.

a. Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.
What are the basic assumptions on which this model is based? (6 Marks)

b. Currently, the rate of return on the Federal Government Bond redeemable at par in the year 2018 is 5%. The securities of four companies, Akira Plc., Bombadia Plc., Courage Plc., and Divine Plc., have expected returns of 12%, 9.5%, 10.5%, and 13%, respectively. The average expected return on the market portfolio is 10%, subject to a 6% risk (standard deviation). Other relevant information relating to the four securities of the companies is as stated below:

Company Standard Deviation Correlation Coefficient
Akira Plc 0.080 0.975
Bombadia Plc 0.075 0.640
Courage Plc 0.090 0.740
Divine Plc 0.150 0.680

You are required to show which of the companies is/are overvalued. (9 Marks)

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  • 20 Marks

FM – May 2019 – L3 – Q5 – Portfolio Management

Evaluate whether an option price is fair for hedging Yaro Plc. shares, and explain how changes in volatility and the risk-free rate affect the value of a call option.

You are the portfolio manager of an asset management company based in Kano. Your company has in its portfolio 27,750,000 shares of Yaro Plc., a company listed on the Nigerian Stock Exchange. The shares are currently trading at N3.60 per share.

Your company plans to sell the shares in six months’ time to pay dividends, and you plan to hedge the risk of Yaro’s shares falling by more than 5% from their current market value. A decision has therefore been taken to buy an over-the-counter option to protect the shares. A merchant bank has offered to sell an appropriate six-month option to your company for N1,250,000.

Yaro’s share price has an annual standard deviation of 13%, and the risk-free rate is 4% per year.

Required:

a. Evaluate whether or not the price at which the merchant bank is willing to sell the option is a fair price.

b. Explain briefly (without any calculations) how a decrease in the value of each of the following variables is likely to change the value of a call option:
i. Volatility of the stock price
ii. Risk-free rate

(Total: 15 Marks)

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  • 20 Marks

FM – May 2019 – L3 – Q4 – Portfolio Management

Evaluate abnormal returns for shares and bonds, calculate required returns for a pension fund portfolio, and assess its active management strategy.

The managers of a pension fund follow an active portfolio management strategy. They try to purchase shares and bonds that show a positive abnormal return (positive alpha factor in the case of shares). The pension fund is required by law to hold at least 40% of its investments in bonds. N100million is currently available for
investment. Three shares and three bonds are being considered for purchase. The required return on bonds may be measured using a model similar to the capital asset pricing model, where beta is replaced by the relative duration of the individual bond (Di) and the bond market portfolio (Dm) i.e. Di/Dm.

Note: Assume the risk-free rate is 4 percent per year.

Required:

a. Evaluate whether or not any of the shares or bonds is expected to offer a positive abnormal return. (10 Marks)

b. The pension fund currently has the maximum permitted investment in shares and wishes to continue this strategy. It has a market value of N1,000 million and a beta of 0.62.

Required:
Calculate the required return from the pension fund if any shares and bonds with positive abnormal returns are purchased. State clearly any assumptions that you make. (4 Marks)

c. Discuss possible problems with the pension fund’s investment strategy. (6 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q6 – Portfolio Management

Evaluate Tico Plc’s share price using CAPM, identify potential errors in valuation, and discuss limitations of portfolio theory in physical investment decisions.

Tico Plc is comprised of only four major investment projects, details of which are as follows:

Project % of Company Market Value Annual % Return During Last 5 Years Risk % Standard Deviation Correlation with the Market
1 28 10 15 0.55
2 17 18 20 0.75
3 31 15 14 0.84
4 24 13 18 0.62

The risk-free rate is expected to be 5% per year, the market return 14% per year, and the standard deviation of market returns 13%.

Required:

a. Assume that Tico Plc’s shares are currently priced based upon the assumption that the last five years’ experience of returns will continue for the foreseeable future. Evaluate whether or not the share price of Tico Plc is undervalued or overvalued. (8 Marks)

b. Discuss why your results in (a) above might not correctly identify whether or not the share price of Tico Plc is undervalued or overvalued. (6 Marks)

c. Briefly discuss the key limitations of portfolio theory in the analysis of physical investment decisions in practice. (6 Marks)

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  • 6 Marks

FM – Nov 2016 – L3 – Q5a – Portfolio Management

Explanation of the basic assumptions of the Capital Asset Pricing Model (CAPM).

(a) Capital Asset Pricing Model (CAPM) is an equilibrium model of the trade-off between expected portfolio return and unavoidable risk.

What are the basic assumptions on which this model is based?

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  • 15 Marks

FM – Nov 2021 – L3 – Q6 – Portfolio Management

Analyze the risk profile of Bettaluck plc's short-term equity portfolio and assess investment adjustments based on market returns and financial strategy.

Bettaluck plc is experiencing a substantial net cash inflow, which has been temporarily invested in a short-term equity portfolio. This portfolio consists of investments in four Nigerian listed companies. The funds are intended to meet tax obligations, dividend payments, and future capital expenditures in several months.

Portfolio Details:

Required:

a. Based on the data provided, calculate the risk (i.e., Beta) of Bettaluck’s short-term investment portfolio relative to the market. (4 Marks)

b. Recommend whether the composition of Bettaluck’s short-term investment portfolio should be adjusted. Provide reasons for your recommendation, including relevant calculations. (6 Marks)

c. Discuss the factors a financial manager should consider when investing in marketable securities. (5 Marks)

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  • 20 Marks

FM – May 2018 – L3 – SB – Q4 – Portfolio Management

Analyze SF Plc.'s portfolio beta and assess whether the short-term investment strategy is optimal.

Sunmola Funds (SF) Plc. has a portfolio of short-term investments in the shares of four quoted companies.

Company Holding
Tomiwa (T) 100,000 shares
Pascal (P) 155,000 shares
Binta (B) 260,000 shares
Yetunde (Y) 420,000 shares

You have the following additional information:

Company Beta Market Value Per Share (Kobo) Expected Total Return on Investment p.a (%)
T 1.55 280 21.0
P 0.65 340 12.5
B 1.26 150 18.0
Y 1.14 9.5 18.5

The market risk premium is 10% per year, and the risk-free rate is 6% per year.

Required:

a. Estimate the Beta of SF Plc.’s short-term investment portfolio. (4 Marks)

b. Recommend, giving your reasons, whether the composition of SF Plc.’s short-term investment portfolio should be changed using relevant calculations. (10 Marks)
Hint: Consider the alpha values of the shares and the propriety of investing short-term funds in equity.

c. Explain THREE factors that a financial manager should take into account when investing in marketable securities. (6 Marks)

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  • 15 Marks

FM – Nov 2017 – L3 – Q7 – Portfolio Management

Evaluate investment risk in different portfolio scenarios and explain the implications of beta and alpha values for KT Plc’s equity.

a. In the context of the selection and holding of investments, discuss each of the following scenarios:

i. An investor holding only one security needs to be concerned with the unsystematic risk of that security. (3 Marks)

ii. However, an investor who holds a number of securities should take account of total risk. (3 Marks)

iii. An investor should never add to a portfolio an investment that yields a return less than the market rate of return. (3 Marks)

b. The equity beta of KT Plc. is 1.2 and the equity alpha is 1.4. Explain the meaning and significance of these values to the company. (6 Marks)

(Total 15 Marks)

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