Page 300 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 11: Capital Market Theory

11.15 Review Questions Notes

1. Can an investor receive a higher expected return for the same level of systematic risk? If
yes, explain under which conditions, if no- answer why not.

2. Examine the concept of the Beta factor of a market portfolio.
3. What do you analyse as the benefits and limitations of CAPM.
4. Do you think that the assumptions of CAPM are practical? Why/why not?

5. Critically evaluate Arbitrage Pricing Model.
6. What do you see as the difference between arbitrage and the APT?
7. Explain arbitrage mechanics.
8. As an investor, how do you use the APT?
9. Analyse the modern portfolio theory and present a short write-up on its utility in wake of
the current global crisis.
10. Examine the concept of Efficient Frontier.
11. RKS Ltd. has an expected return of 22% and standard deviation of 40%. BBS Ltd. has an
expected return of 24% and standard deviation of 38%. RKS Ltd. has a beta of 0.86 and BBS
Ltd. a beta of 1.24. The correlation coefficient between the return of RKS Ltd. and BBS Ltd.
is 0.72. The standard deviation of the market return is 20%. Suggest:
(a) Is investing in BBS Ltd. better than investing in RKS Ltd.? (H) If you invest 30% in
BBS Ltd. and 70% in RKS Ltd.,
(b) What is your expected rate of return and portfolio standard deviation?
(c) What is the market portfolio’s expected rate of return and how much is the risk-free
rate?
12. Wipro Limited pays no taxes and is entirely financed by equity shares. The equity share
has a beta of 0.6, a price-earning ratio of 12.5 and is priced to offer an expected return of
20%. Wipro Ltd. now decides to buy back half of the equity shares by borrowing an equal
amount. If the debt yields a risk free return of 10%, calculate:
(a) The beta of the equity shares after the buyback.
(b) The required return and risk premium on the equity shares before the buyback.
(c) The required return and risk premium on the equity shares after the buyback.
(d) The required return on debt.

(e) The percentage increase in expected earnings per share.
(f) The new price-earning multiple.
Assume that the operating profit of the firm is expected to remain constant in perpetuity.

Answers: Self Assessment

1. higher, higher 2. Capital Asset Pricing Model

3. tangency 4. Security Market Line (SML)
5. 'characteristic line' 6. 'market neutral'

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