SAPM Solved Papers May' 2018, Dibrugarh University B.Com 4th/6th Sem

Security Analysis and Portfolio Management Solved Question Paper May 2018
2018 (May)
COMMERCE (Speciality)
Course: 404 (Security Analysis and Portfolio Management)
Full Marks: 80
Pass Marks: 24 Marks
Time: Three hours
The figures in the margin indicate full marks for the questions

1. What do you mean by the following (answer in 1 sentence)?                                1x8=8

1)    Time value of money: Time value of money is the concept that the value of a rupee to be received in future is less than the value of a rupee on hand today.

2)    Beta: Beta attempts to measure an investment's sensitivity to market movements. A high beta means that an investment is highly volatile and that it will likely outperform its benchmark in up markets, thus exceeding the benchmark's return, and underperform it in down markets. A lower beta means an investment is likely to underperform its benchmark in up markets, but is likely to do better when the markets fall.

3)    Risk: Risk may be described as variability/fluctuation/deviation of actual return from expected return from a given asset/investment. Higher the variability, greater is the risk. In other words, the more certain the return from an asset, lesser is the variability and thereby lesser is the risk.

4)    Expenditure: Investment expenditure refers to the expenditure incurred either by an individual or any financial institutions in the acquisition of various types of investments such as shares, debentures, bonds etc.

5)    Diversification: Risks involved in investment and portfolio management can be reduced through a technique called diversification. Diversification is a strategy of investing in a variety of securities in order to lower the risk involved with putting money into few investments. The traditional belief is that diversification means “Not putting all eggs in one basket.” Diversification helps in the reduction of unsystematic risk and promotes the optimization of returns for a given level of risks in portfolio management.

6)    Portfolio: portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non publicly tradable securities, like real estate, art, and private investments.

7)    Security market line (SML) is the representation of the Capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk (its beta). It is also referred to as the "characteristic line".

👉Also Read: Dibrugarh University SAPM Solved Question Papers

SAPM Solved Paper May' 2013

SAPM Solved Paper May' 2014

2. Write short notes on the following (any four): 4x4=16

a) Unsystematic risk: Unsystematic Risk refers to that portion of total risk that is unique or peculiar to a firm or an industry, above and beyond that affecting securities markets in general. Factors like consumer preferences, labour strikes, management capability etc. cause unsystematic risk (variability of returns) for a company’s stock. Unlike systematic risk, the unsystematic risk can be reduced/avoided through diversification. Total risk of a fully diversified portfolio equals to the market risk of the portfolio as its specific risk becomes zero.

b) Traditional portfolio analysis: Traditional portfolio analysis has been of a very subjective nature for each individual. The investors made the analysis of individual securities through the evaluation of risk and return conditions in each security. The normal method of finding the return on an individual security was by finding out the amounts of dividends that have been given by the company, the price earning ratios, the common holding period and by an estimation of the market value of the shares. The traditional theory assumes that selection of securities should be based on lowest risk as measured by its standard deviation from the mean of expect returns. The greater the variability of returns the greater is the risk. Thus, the investor chooses assets with the lowest variability of returns.

c) Capital Market Line (CML): Capital Market Line (CML) is a line used in the capital asset pricing model to illustrate the rates of return for efficient portfolios depending on the risk-free rate of return and the level of risk (standard deviation) for a particular portfolio.

The CML is derived by drawing a tangent line from the intercept point on the efficient frontier to the point where the expected return equals the risk-free rate of return. The CML is considered to be superior to the efficient frontier since it takes into account the inclusion of a risk-free asset in the portfolio.

The CML is the relationship between the risk and the expected return for portfolio. The CML results from the combination of the market portfolio and the risk-free asset. All points along the CML have superior risk-return profiles to any portfolio on the efficient frontier, with the exception of the Market Portfolio, the point on the efficient frontier to which the CML is the tangent. From a CML perspective, this portfolio is composed entirely of the risky asset, the market, and has no holding of the risk free asset ,i.e., money is neither invested in, nor borrowed from the money market account.

d) Jensen Model: Jensen's model proposes another risk adjusted performance measure. This measure was developed by Michael Jensen and is sometimes referred to as the Differential Return Method. This measure involves evaluation of the returns that the fund has generated vs. the returns actually expected out of the fund given the level of its systematic risk. The surplus between the two returns is called Alpha, which measures the performance of a fund compared with the actual returns over the period. Required return of a fund at a given level of risk (b) can be calculated as:

Rt – R = a + b (Rm – R)

Where, Rt = Portfolio Return

R = Risk less return

a = Intercept the graph that measures the forecasting ability of the portfolio manager.

b = Beta coefficient, a measure of systematic risk

Rm = Return of the market portfolio

Thus, Jensen’s equation involves two steps:

(i) First he calculates what the return of a given portfolio should be on the basis of b, Rm and R.

(ii) He compares the actual realised return of the portfolio with the calculated or predicted return. Greater the excess of realised return over the calculated return, better is the performance of the portfolio.

Limitation of this model is that it considers only systematic risk not the entire risk associated with the fund and an ordinary investor can not mitigate unsystematic risk, as his knowledge of market is primitive.

e) Efficient Market: In an efficient market, all the relevant information is reflected in the current stock price. Information cannot be used to obtain excess return: the information has already been taken into account and absorbed in the prices. Tests of the market efficiency are tests of whether the three general types of information – past prices, other public information and inside information can be used to make above-average returns on investments. These tests of market efficiency have also been termed as weak-form (price information), semi strong form (other public information) and strong form (inside information) tests.

3. What do you mean by fundamental analysis and technical analysis? Bring out clearly the points of distinction between the two.                            8+6=14

Ans: Meaning of fundamental analysis

Fundamental analysis is method of finding out the future price of a stock which an investor wishes to buy. Fundamental analysis is used to determine the intrinsic value of the share of a company to find out whether it is overpriced or under priced by examining the underlying forces that affect the well being of the economy, Industry groups and companies.

Fundamental analysis is simply an examination of future earnings potential of a company, by looking into various factors that impact the performance of the company. The prime objective of a fundamental analysis is to value the stock and accordingly buy and sell the stocks on the basis of its valuation in the market. The fundamental analysis consists of economic, industry and company analysis. This approach is sometimes referred to as a top-down method of analysis.

Meaning of technical analysis

In fundamental analysis, a value of a stock is predicted with risk-return framework based on economic environment. An alternative approach to predict stock price behaviour is known as technical analysis. It is frequently used as a supplement rather than as a substitute to fundamental analysis. Technical analysis is based on notion that security prices are determined by the supply of and demand for securities. It uses historical financial data on charts to find meaningful patterns, and using the patterns to predict future prices.

In the words of Edwards and Magee: “Technical analysis is directed towards predicting the price of a security. The price at which a buyer and seller settle a deal is considered to be the one precise figure which synthesizes, weights and finally expresses all factors, rational and irrational quantifiable and non-quantifiable and is the only figure that counts”.

Difference between technical and fundamental analysis

The key differences between technical analysis and fundamental analysis are as follows:

1.       Technical analysis mainly seeks to predict short term price movements, whereas fundamental analysis tries to establish long term values.

2.       The focus of technical analysis is mainly on internal market data, particularly price and volume data. The focus of fundamental analysis is on fundamental factors relating to the economy, the industry, and the firm.

3.       Technical analysis appeals mostly to short-term traders i.e. speculators, whereas fundamental analysis appeals primarily to long-term investors.

4.       Technical analysis is the a simple and quick method on forecasting behaviour of stock prices. Whereas, fundamental analysis involves compilation and analysis of huge amount of data and is therefore, complex, time consuming and tedious in nature.

5.       The technical analysis is based on the premise that the history repeats itself. Therefore, the technical analysis answers the question “What had happened in the market” while on the basis of potentialities of market fundamental analysis answers the question, “What will happen in the market”.

6.       The technical analysis assumes that the market is 90 percent psychological and 10 percent logical, while the fundamental analysis believes that the market is 90 percent logical and 10percent psychological.

7.       The technical analysis seeks to estimate security prices rather than values, while the fundamental analysis estimates the intrinsic value of a security.

8.       According to technical analysts, their method is far superior than the fundamental analysis, because fundamental analysis is based on financial statements which themselves are plagued by certain deficiencies like subjectivity, inadequate disclosure etc.


Define the term ‘investment’. Discuss the different avenues available to an investor for making investment.  4+10=14


Investment is the employment of funds with the aim of getting return on it. In general terms, investment means the use of money in the hope of making more money. In finance, investment means the purchase of a financial product or other item of value with an expectation of favorable future returns.

Investment of hard earned money is a crucial activity of every human being. Investment is the commitment of funds which have been saved from current consumption with the hope that some benefits will be received in future. Thus, it is a reward for waiting for money. Savings of the people are invested in assets depending on their risk and return demands.

Investment refers to the concept of deferred consumption, which involves purchasing an asset, giving a loan or keeping funds in a bank account with the aim of generating future returns. Various investment options are available, offering differing risk-reward tradeoffs. An understanding of the core concepts and a thorough analysis of the options can help an investor create a portfolio that maximizes returns while minimizing risk exposure.


Wide varieties of investment avenues are now available in India. An investor can himself select the best avenue after studying the merits and demerits of different avenues. Even financial advertisements, newspaper supplements on financial matters and investment journals offer guidance to investors in the selection of suitable investment avenues. Investment avenues are the outlets of funds. A wide range of investment alternatives are available, they fall into two broad categories, viz, financial assets and real assets. Financial assets are paper (or electronic) claim on some issuer such as the government or a corporate body. The important financial assets are equity shares, corporate debentures, government securities, deposit with banks, post office schemes, mutual fund shares, insurance policies, and derivative instruments. Real assets are represented by tangible assets like residential house, commercial property, agricultural farm, gold, precious stones, and art object. As the economy advances, the relative importance of financial assets tends to increase. Some of the important investment alternatives are given below:

a)      Non-marketable Financial Assets: A good portion of financial assets is represented by non-marketable financial assets. A distinguishing feature of these assets is that they represent personal transactions between the investor and the issuer. For example, when you open a savings bank account at a bank you deal with the bank personally. In contrast when you buy equity shares in the stock market you do not know who the seller is and you do not care. These can be classified into the following broad categories:

1)      Post office deposits

2)      Company deposits

3)      Provident fund deposits

4)      Bank deposits

b)      Equity shares: By investing in shares, investors basically buy the ownership right to that company. When the company makes profits, shareholders receive their share of the profits in the form of dividends. In addition, when a company performs well and the future expectation from the company is very high, the price of the company’s shares goes up in the market. This allows shareholders to sell shares at profit, leading to capital gains. Investors can invest in shares either through primary market offerings or in the secondary market.

c)       Preference Shares: Preference shares refer to a form of shares that lie in between pure equity and debt. They have the characteristic of ownership rights while retaining the privilege of a consistent return on investment. The claims of these holders carry higher priority than that of ordinary shareholders but lower than that of debt holders. These are issued to the general public only after a public issue of ordinary shares.

d)      Debentures and Bonds: These are essentially long-term debt instruments. Many types of debentures and bonds have been structured to suit investors with different time needs. Debentures and Bonds are the instruments that are considered as a relatively safer investment avenues. Though having a higher risk as compared to bank fixed deposits, bonds, and debentures do offer higher returns.

e)      Mutual Fund Schemes: The Unit Trust of India is the first mutual fund in the country. A number of commercial banks and financial institutions have also set up mutual funds. Mutual funds have been set up in the private sector also. These mutual funds offer various investment schemes to investors. The number of mutual funds that have cropped up in recent years is quite large and though, on an average, the mutual fund industry has not been showing good returns, select funds have performed consistently, assuring the investor better returns and lower risk options.

f)        Money market instrument: By convention, the term "money market" refers to the market for short-term requirement and deployment of funds. Money market instruments are those instruments, which have a maturity period of less than one year. Examples of money market instruments are T-Bills, Certificate of Deposit, Commercial Paper etc.

g)      Life insurance: Now-a-days life insurance is also being considered as an investment avenue. Insurance premiums represent the sacrifice and the assured sum the benefit. Under it different schemes are:

1)      Endowment assurance policy

2)      Money back policy

3)      Whole life policy

4)      Term assurance policy

h)      Real estate: With the ever-increasing cost of land, real estate has come up as a profitable investment proposition.

i)        Bullion Investment: The bullion market offers investment opportunity in the form of gold, silver, and other metals. Specific categories of metals are traded in the metals exchange. The bullion market presents an opportunity for an investor by offering returns and end value in future. It has been observed that on several occasions, when the stock market failed, the gold market provided a return on investments.

j)        Financial Derivatives: These are such instruments which derive their value from some other underlying assets. It may be viewed as a side bet on the asset. The most important financial derivatives from the point of view of investors are Options and Futures.

4. Discuss the need and significance of diversification in a portfolio construction.             14

Ans: Diversification: Risks involved in investment and portfolio management can be reduced through a technique called diversification. Diversification is a strategy of investing in a variety of securities in order to lower the risk involved with putting money into few investments. The traditional belief is that diversification means “Not putting all eggs in one basket.” Diversification helps in the reduction of unsystematic risk and promotes the optimization of returns for a given level of risks in portfolio management.

 Diversification may take any of the following forms:

a)       Different Assets e.g. gold, bullion, real estate, government securities etc.

b)      Different Instruments e.g. Shares, Debentures, Bonds, etc.

c)       Different Industries e.g. Textiles, IT, Pharmaceuticals, etc.

d)      Different Companies e.g. new companies, new product company’s etc.

Proper diversification involves two or more companies/industries whose fortunes fluctuate independent of one another or in different directions. One single company/industry is always more risky than two companies/industries. Two company’s in textile industry are more risky than one company in textile and one in IT sector two companies/industries which are similar in nature of demand a market are more risky than two in dissimilar industries.

Importance of Diversification in Portfolio Management

Diversification of investments is significant due to the following reasons:

1. Reduce the risk: Every stock or financial instrument carries some amount of risk with it except the risk-free investments. With portfolio diversification, one cannot completely remove the risks but can reduce the risk to a great extent. Without proper diversification amongst the different classes of the assets, the risk of investment rises with every investment we make. One needs to include both risky asset classes such as high- return generating stocks and to hedge their risk they should invest in fixed income assets. Diversification gradually reduces the risk of the portfolio over time.

2. Helps In Hedging: If investments are entirely made in stock market, then in case of excessive volatility the return on investments will dropped significantly. However, if they investors kept a certain amount of other investment assets like commodities, bonds, metals in their portfolio, their profits would have been higher because loss or low profits of the stock market would have been wiped off by the positive returns of the commodities market. Diversification helps in achieving desired or better returns even when the market is slow as there are other markets which make up for the negative or low yields of the former market. This way investors can hedge their investments and earn potential returns through portfolio diversification.

3. Provide Higher Returns: Since the market keeps on changing, we need to diversify with asset classes which are not correlated. Correlation plays the most critical role in determining returns. If we are investing in one market which is connected to the other, when the former goes down, that will substantially affect the other. We need to choose investment vehicles which are entirely different from each other. That’s why we need a diversified portfolio.

4. Aligning Portfolio With Financial Aspirations: As per the Behavioural portfolio theory, either our investment will give us the potential for high-growth, or it will protect from negative returns. This theory states that when a portfolio is diversified, it corresponds to a pyramid structure. A properly diversified portfolio has the maximum of low-risk investments and provides value growth and steady income generation. ‘Blend’ funds comprise the top of this pyramid which is a mix of risky and low-risk investment instruments. The regular income generating investments will provide with periodic income, and the blend funds will grow in value, and together they bring stability of investment and higher wealth accumulation.

5. Investment Mix Adjustment: Portfolio diversification allows us to modify investment mix as per changing financial needs and market changes. With age, the investment mix also needs to be changed as the tenure for investments keeps on reducing. While we start off with high-risk investment instruments, with time flowing, we must reduce our risk by shifting more towards fixed income financial instruments for regular earnings. While an investor of 20’s age group can assign 90% of his investment into stocks, investor of 50’s age group must have not more than 40% allocated to equities. That’s why we need a diversified portfolio.


Explain the Markowitz portfolio theory. What are the assumptions of Markowitz portfolio theory? 6+8=14


Dr. Harry M. Markowitz was the person who developed the first modern portfolio analysis model. Markowitz used mathematical programming and statistical analysis in order to arrange for the optimum allocation of assets within portfolio. He infused a high degree of sophistication into portfolio construction by developing a mean-variance model for the selection of portfolio. Markowitz approach determines for the investors the efficient set of portfolio through three importance variables - Return, standard deviation and coefficient of correlation.

Markowitz model is called the “Full Covariance Model”. Through this method the investor can find out the efficient set of portfolio by finding out the trade off between risk and return, between the limits of zero and infinity. Markowitz theory is based on several assumptions these are:


Based on thorough and scientific research, Markowitz has set down his own guidelines for diversification:

a)       The investments have different types of risk characteristics. Some are systematic or market related risks and the others are unsystematic or company related risks.

b)      His diversification involves a proper number of securities not too less nor too many.

c)       The securities have no correlation or negative correlation.

d)      Last is the proper choice of the companies, securities or assets whose returns are not related and whose risks are mutually off setting to reduce the overall risk.

Markowitz lays down three parameters for building up the efficient set of portfolio:

a)       Expected returns.

b)      Standard deviation from mean to measure variability of returns.

c)       Covariance or variance of one asset return to other asset returns.

To generalize, higher the expected return, lower will be the standard deviation or variance and lower is the correlation. In such a case, better will be the security for investor choice. If the covariance of the securities’ returns is negative or negligible, the total risk of the portfolio of all securities may be lower as compared to the risk of the individual securities in isolation.

By developing his model, Markowitz first did away with the investment behaviour rule that the investor should maximize expected return. This rule implied that the non-diversified single security portfolio with the highest expected return is the most desirable portfolio. Only by buying that single security can expected return be maximized. The single security portfolio can be much preferred if the higher return turns out to be the actual return. However, in real world, there are conditions of so much uncertainty that most risk averse investors, joint with Markowitz in adopting diversification of securities.


a)       The markets are efficient and absorb all the information quickly and perfectly. So an investor can earn superior returns either by technical analysis or fundamental analysis. All the investors are in equal category in this regard.

b)      Investors are risk averse. Before making any investments, all of them, have a common goal-avoidance of risk.

c)       Investors are rational. They would like to earn the maximum rate of return with a given level of income or money.

d)      Investors base their decisions solely on expected return and variance (or standard deviation) of returns only.

e)      For a given risk level, investors prefer high returns to lower returns. Similarly, for a given level of expected return, they prefer less risk to more risk.

f)        The investor can reduce the risk if he adds investments to his portfolio.

g)       Investors consider each investment alternative as being represented by a probability distribution of expected returns over some holding period.

h)      A portfolio of assets under the above assumptions is considered to be efficient if no other portfolio of assets offers higher expected return with the same (or lower) risk or lower risk with the same (or higher) expected return.

5. What are the basic assumptions of CAPM? Write down the difference between CAPM and APT model.  6+8=14

Ans: Assumptions of CAPM

The capital asset pricing model is based on certain explicit assumptions regarding the behavior of investors. The assumptions are listed below:

1.       Investor make their investment decisions on the basis of risk-return assessments measured in terms of expected returns and standard deviation of return.

2.       The purchase or sale of a security can be undertaken in infinitely divisible unit.

3.       Purchase and sale by a single investor cannot affect prices. This means that there is perfect competition where investors in total determine prices by their action.

4.       There are no transaction costs. Given the fact that transaction costs are small, they are probably of minor importance in investment decision-making, and hence they are ignored.

5.       There are no personal income taxes. Alternatively, the tax rate on dividend income and capital gains are the same, thereby making the investor indifferent to the form in which the return on the investment is received (dividends or capital gains).

6.       The investor can lend or borrow any amount of fund desired at a rate of interest equal to the rate of risk less securities.

7.       The investor can sell short any amount of any shares.

8.       Investors share homogeneity of expectations. This implies that investors have identical expectations with regard to the decision period and decision inputs. Investors are presumed to have identical expectations regarding expected returns, variance of expected returns and covariance of all pairs of securities.

Difference between APT and CAPM

a)       APT computes the expected return on a security based on the security’s sensitivity to movements in macroeconomic factors. Whereas, CAPM is a tool used by investors to determine the risk associated with a potential investment and also gives an idea as to what can be the expected return on the investment.

b)      The APT can be set up to consider several risk factors, such as the business cycle, interest rates, inflation rates, and energy prices. The model distinguishes between systematic risk and firm-specific risk and incorporates both types of risk into the model for each given factor. Where as CAPM considers only systematic risk, reflecting a reality in which most investors have diversified portfolios from which unsystematic risk has been essentially eliminated.

c)       APT is based on factor model of return and arbitrage Whereas CAPM is based on investors’ portfolio demand and equilibrium.

d)      APT is a multifactor model where as CAPM is a single factor model.

e)      APT places emphasis on covariance between asset returns and exogenous factors whereas CAPM places emphasis on covariance between asset returns and endogenous factors.

f)        APT model works better in multi period cases as against CAPM which is suitable for single period cases only. 


GAIL Investment Company manages a portfolio consisting of 6 stock with the following information:

Name of the scrip

Market value (Rs.)


Essar Steels Ltd.

TATA Steels Ltd.


Andhra Steels Ltd.

Mittal Steels Ltd.

Varun Steels Ltd.













The risk-free rate of interest is 6 percent and the market return is 13 percent. Estimate the portfolio expected return and portfolio beta.           8+6=14

6. Explain the different methods of measurement of portfolio performance.                       14

Ans: Portfolio performance evaluation and methods of its assessment

Portfolio performance evaluation can be defined as a feedback and control mechanism which is used by the portfolio managers and investment analysts to make the process of portfolio/investment management more effective. Expert Portfolio managers have to show superior performance over the market; for that they have to evaluate their performance in comparison with other portfolio managers. Portfolio manager have an objective to achieve an optimum risk return adjustment. Whether they are heading towards this objective or not will be found out only if they evaluate their portfolios periodically. However, in conducting such an evaluation, a means for determining the appropriate standard or benchmark must be established. Two major factors which influence the performance are the rate of return earned and the associated risk over the relevant period. The return is defined to include changes in the value of the fund over the performance period plus any income earned over that period. Risk is the variability surrounding the return. The manager has to diversify completely into different industries, assets and instruments so as to reduce the unsystematic risk to the minimum for a given level of return. The systematic or market related risk has to be managed by a proper selection of beta for the securities.

Methods of assessing performance

The portfolio performance is evaluated by measuring and comparing the portfolio return and associated risk and hence risks adjusted performance. For this purpose, there are essentially three major methods of assessing performance:

a)       Return per unit of risk.

b)      Differential return.

c)       Components of performance.

a)       Return per Unit of Risk: The first measure of risk adjusted performance assesses the performance of a fund in terms of return per unit of risk; both in absolute terms and relative terms (relative to overall market performance). According to this measure, funds that provide the highest return per unit of risk would be adjudged as the best performers and the funds that provide the lowest return per unit of risk would be the poorest performers. There are two methods of determining the return per unit of risk.

Ø  Reward to volatility ratio developed by William Sharpe and

Ø  Reward to volatility ration developed by Jack Treynor.

Evaluation has also to take into account whether the portfolio is securing above average returns, average returns or below average returns as compared to the prevailing rate of return in the market. The ability of the fund managers to diversity can reduce and even eliminate all unsystematic risk. They can manage the systematic risk by use of appropriate risk measures, namely Betas. The portfolio managers must have superior timing and superior stock selection to earn above average returns. Diversification can reduce the market related risk and maximize the returns for a given level of risk. As the market returns are positively related to risk, the evaluators must take into consideration (a) The rate of returns, (b) Excess return over risk free rate, (c) Level of systematic, unsystematic and residual risk through proper diversification.

b)      Differential Return: Another method to measure the risk adjusted performance is the differential return measure. This measure was developed by Michael Jensen. The basic objective of this technique is to calculate the return that should be expected for the fund given the realized risk of the fund and then comparing the calculated return with the actually realized return. In making this comparison, it is assumed that the investor plays a very passive role. He merely buys the market portfolio and adjusts for the appropriate level of risk by borrowing or lending at the risk free rate.

c)       Components of Performance: The first two measures stated above are primarily concerned with the overall performance of a fund. However, the more useful measure would be to assess the sources and components of performance by developing a more refined breakdown. E. Fama has provided an analytical framework to have a more detailed break down of the performance of the fund. This break down is done in the following three ways:

1.       Stock Selection: Overall performance of the fund can be examined in terms of superior or inferior stock selection and the normal return associated with a given level of risk. Thus, Total Excess Return = Selecting + Risk.

To earn average returns, the fund managers have to diversify. The market pays returns only on the basis of systematic risk. The level of diversification can be judged on the basis of the correlation between the portfolio returns and the returns for a market portfolio. A completely diversified portfolio is perfectly correlated with the market portfolio, which is in turn completely diversified.

To earn the above average return, fund managers will generally have to forsake some diversification that will have its cost in terms of additional portfolio risk. Hence some additional return is needed for this additional diversification risk. Capital Market Line (CML) helps in determining the risk commensurate with the incurred risk.

2.       Market Timing: If investors want to maximize their returns, they must not only purchase the right security but must also know the right time to purchase and sell. To generate superior performance better than the market average, markets, have to be timed correctly. Market timing implies assessing correctly the direction of the market, either bull or bear and positioning the portfolio accordingly. When there is a forecast of declining market, the managers should position the portfolio properly by increasing the cash percentage of the portfolio or by decreasing the beta of the equity portion of the portfolio. When the forecast is of rising market, the managers should decrease the cash position or increase the beta of the equity portion of the portfolio.

3.       Cash Management Analysis: Cash management analysis was used by Farrell to assess the degree to which variations in the cash percentage around the long term average have benefited or detracted from fund performance. Two indexes were constructed for each fund by Farrell:

Ø  The first index is based on the average cash to other asset allocation experienced by the fund over the period of analysis.

Ø  The second index is based on a quarter to quarter changes experienced by the fund over the period.


The financial performance of the various mutual funds is provided below. The risk-free rate of interest is 6%:

Name of the scheme

Return On Portfolio

Standard Deviation Of the Portfolio


Birla Mutual Fund

TATA Mutual Fund

ICICI Mutual Fund










Rank the funds according to the Sharpe and Treynor Performance Index. 7+7=14

0/Post a Comment/Comments

Kindly give your valuable feedback to improve this website.