Page 290 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 11: Capital Market Theory

However, APM holds that: Notes
E(R) = R + + + +
i f 1 i1 2 i2 3 i3 4 i4
Where,
, , , and the average risk premium for each of the four factors in the model and , ,
1 2 3 4 i1 i2
and are measures of the sensitivity of the particular security ‘i’ to each of the four factors.
i3 i4
Several factors appear to have been identified as being important (some of which, such as
inflation and money supply, industrial production and personal consumption, do have aspects
of being inter-related). In particular, researchers have identified:
1. Changes in the level of industrial production in the economy

2. Changes in the shape of the yield curve
3. Changes in the default risk premium (i.e., changes in the return required on bonds\different
perceived risks of default)

4. Changes in the inflation rate
5. Changes in the real interest rate
6. Level of personal consumption
7. Level of money supply in the economy

Example: As an investment manager you are given the following informations:

Particulars Initial price Dividends Market price at the Beta
( ) ( ) year end ( ) (Risk factor)
Investment in equity shares of A 25 2 50 0.8
Cement Ltd.
Steel Ltd. 35 2 60 0.7
Liquor Ltd. 45 2 135 0.5
B. Government of India bonds 1,000 140 1,005 0.99

Risk-free return may be taken at 14%.
You are required to calculate:
1. Expected rate of returns of portfolio in each using Capital Asset Pricing Model (CAPM).
2. Average return of portfolio.
Solution:

1. Calculation of Expected Rate of Return on Market Portfolio
Investments Amount Invested ( ) Dividends ( ) Capital Gains ( )
A. Equity shares of
Cement Ltd. 25 2 25
Steel Ltd. 35 2 25

Liquor Ltd. 45 2 90
B. Government of India bonds 1,000 140 5
1,105 146 145

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