Birla Institute of Technology & Science, Pilani

Hyderabad Campus
End-semester examination- Semester-I 2021-22
Maximum Marks- 40

Course Name: SAPM Course Code: ECON F412/ FIN F313

Date: 22/12/2021 Time: 9:00a.m.-12:00p.m.
Exam Type-Open Book

 All questions are compulsory.

 There are total 15 questions.
 Marks is mentioned against each question.
 Show all the relevant steps for the answers.
 Writing with pencil is not allowed.
 Graphs should be drawn with pencil and neatly labelled.
 Sharing of calculators and study material is strictly prohibited.

Section A - Short answer type questions- (12x2=24marks)

1. Below are the forecasted interest rates for next 8 quarters. Assuming that the interest rate forecasts are
precise and devoid of significant forecasting error, mention and justify an active bond management
strategy in this context.
Quarters 1 2 3 4 5 6 7 8

Forecasted 5.3% 5.1% 5.1% 4.9% 4.8% 4.7% 4.6% 4.4%

interest rates

2. Mention and explain the psychological factors/ behavioral anomalies that can be used to explain the
following outcomes in financial markets:
(a) Sensex closed higher in most of the Muhurat trading (Trading on Day 1 of the Hindu accounting
calendar Samvat) sessions in last 15 years.
(b) Morningstar 2020 report found that only 23% of all active funds beat their passively managed
peers over the most recent 10-year period.

3. Justify with reasons whether the following statements are true/false:

(a) Single index model cannot be used to estimate variance covariance matrix for firms from the
same industry.
(b) In efficient markets, paying portfolio manager or security analyst will not yield profits on
average.

4. Consider the security characteristic line for the funds securities below:
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 Fund 1 Fund 2
Which security has higher fund specific risk and why? Assuming that both the funds have the
same beta, which one will you prefer and why?

5. Suppose Morgan Stanley estimates that beta of the above portfolio evolves over time given by the
following equation: 𝛽𝑡 = 0.3 + 0.7𝛽𝑡−1 . Find the beta of the portfolio for the next year and the
previous year if current beta is 1.24. Also, comment on the nature of beta over time.

6. Consider that a young Company A is likely to pay Rs.20 dividend next year, Rs.22.50 the year after,
and Rs.25 the following year. The investor believes that the P/E of the firm will converge to the
average P/E of firm by the end of third year. If the forecasted EPS at the end of third year is Rs.50
and average industry P/E is 20, find the value of the stock if the required rate of return is 14.2%.

7. If fair return of A is 19% with a beta of 1.5 and that of B is 16% with a beta of 1.2. Find the risk free
rate and the expected return of the market. Assume CAPM holds. If there is another fund with an
expected return of 20% and beta of 1.6, comment on the mispricing, if any and the investment
strategy.

8. The current dividend of ABC corp. is $2.50, the growth rate is 5% and the market capitalization rate
is 10%. What will be your return on investment if the prices (a) converge to fair price by the end of
one year; (b) grow by 5%? Current market price is $50.

9. Graphically show how a single risky market fund and risk-free fund may be sufficient to generate
different risk-return profiles in the financial market.

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10. Graphically explain why investors will never invest in the convex part of the portfolio possibility
frontier and it is inefficient. Which criteria do we use in this context?

11. Evaluate the relative performance of the two funds using the M-squared measure and the Treynor
ratio:
Portfolio 1: Return: 22%; Risk=30%, beta=1.12
Portfolio 2: Return: 18%; Risk=25%, beta=1.3
The Market return is 25% and SD of market return is 35% and T-bill rate is 5%. Without calculating
mention what will be the conclusions if we use the Sharpe ratio to select the fund. Explain the
intuition of your answer.

12. Consider the closing price of a security for 10 trading sessions. You are already long in the security.
Using 5 day SMA and price line crossover do you get a signal to sell the security? If yes, on which
day? Does it appear to be a false signal? Now suppose you are using the relative strength indicator
(RSI) with 80 and 20 as cut-offs. Do you get a sell signal during the period?
Day Day1 Day2 Day3 Day4 Day5 Day6 Day7 Day8 Day9 Day10
Closing price 100 101.5 101 102 99.5 100 102 103 103.5 105
Relative strength (RS) 3.5 3.75 2.8 2.5 2.1 1.9 1.4 2 2.5 3

Section-B- Long answer type questions (16 marks)

13. Suppose an Angel investor is considering investing in two firms: a clean technology company and a
medicine delivery firm. Assume you are an analyst tracking investment in the start-up ecosystem and
your company is selected as the investment adviser to the angel investor. Based on your estimates the
one year expected return and risk of investing in each of the firms are given below:
𝐸(𝑟𝑐𝑙𝑒𝑎𝑛 𝑡𝑒𝑐ℎ ) = 15%; 𝜎𝑐𝑙𝑒𝑎𝑛 𝑡𝑒𝑐ℎ = 20%; 𝐸(𝑟𝑚𝑒𝑑𝑖𝑐𝑖𝑛𝑒 ) = 12%; 𝜎𝑚𝑒𝑑𝑖𝑐𝑖𝑛𝑒 =

10%; 𝑐𝑜𝑟𝑟𝑒𝑙𝑎𝑡𝑖𝑜𝑛 = 1/2

(a) You meet the angel investor and explain that the minimum risk associated with the
investment in these firms is ________. Show all the relevant steps to arrive at the answer.
(b) If the angel investor is planning to invest $1billion in these two risky start-ups, what will be
your suggestion in terms of investment in each of these two firms if the T-Bill rate is 5%.
(c) Suppose that the angel investor’s index of risk aversion is 6. Assuming that $1billion is the
optimal allocation to the risky part of the portfolio, find the original investable sum across
risky and risk-free portfolios. Explain the position of the angel investor. Now, suppose after
your meeting with the angel investors, you come to know that that the now the T-Bill rate has
increased to 5.5% from 5% p.a. Explain how your suggestion to the angel investor would
change. Assume everything else remain unchanged. (No need to calculate) (2+2+2=6)
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14. (a) Suppose you are the Chief Risk Officer of a pension company. Suppose you have a single 7-year
retirement product that pays a coupon of 15.3% per annum with a face value of $1000. You wish to
adopt an immunization strategy by investing in a 5 year and 10year zero coupon bonds with FV
$1000 trading at par. If the yield curve is flat at 10% find the duration. Also, what will be the change
in value of the bond if interest rate changes from 10% to 10.2%. Further, graphically explain what
will be the problem if interest rates suddenly fall by 2 percentage points and we keep using the
duration approximation to assess price change?
(b) Firm XYZ is required to make a $4M payment in 3 years. The yield curve is flat at 10% with
annual compounding. Firm XYZ wants to form a portfolio using 2- year and 4-year zero coupon
bonds to fund the payments. How much of bond must the portfolio contain for it to still be able to
fund the payments irrespective of interest rate changes? What will be the strategy after 1 year?
(4+2=6)

15. The table below gives the weekly closing prices of a stock and the market for 8 weeks. Write down
the equation obtained by estimating the market model. Is this an aggressive or defensive stock?
Justify your answer.

Closing price of
Week stock Closing price of the market
1 580 15000
2 599 15500
3 620 15225
4 585 14950
5 540 14550
6 500 15020
7 490 15530
8 510 16010

Now, suppose that the GDP growth forecast for the next 4 quarters are given below:
Quarter 1 2 3 4
GDP growth -1.1% -2.03% -3.3% -1.8%
(forecasted)

Would you want to invest in this security? Why or why not.

(Note: Slope=Cov(x,y)/Var(x); Intercept= mean of y-slope*mean of x) (4)

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