SFM Compiler 4th Edition Volume 1

For May, 2023 Onwards
33 Past Exam Papers (May 2008 to May 2022)

28 Revision Test Papers (Nov 2011 to May 2022)
38 Mock Test Papers (Feb 2014 to May 2022)
2022 ICAI Study Material
Relevant Questions from Old Practice Manual
637 Practical Questions
309 Theory Questions
Chapterwise Marks Distribution of Past Exams 4th
5
131 19
95 159
40 274
4
th
285 323
4 th (Aug-22)
Applicable - May 2023 Onwards
80802 53148, 84480 70071

May Dec Jul Easy to
Score in Short
2022 2021 2021 Duration
4 - 4 2 XIV
4 4 4 4 XIII
8 4 - 4 XII
8 8 24 13 II
16 20 16 13 III
4 4 4 5 XI
16 8 12 10 VI
8 16 8 11 V
12 4 12 6 X
8 16 8 14 I
12 16 8 10 VII
8 8 8 9 VIII
8 8 8 11 IV
8 8 8 7 IX
NA NA NA
124 124 124

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CA Mayank Kothari 2. Risk Management
CHAPTER
`
2
RISK MANAGEMENT
Question 1
Neel holds ₹1 Crore shares of XY Ltd. Whose market price standard deviation is 2% per day.
Assuming 252 trading days in a year, determine maximum loss level over the period of 1 trading
day and 10 trading days with 99% confidence level. Assuming share prices are normally for level
of 99%, the equivalent Z score from Normal table of Cumulative Area shall be 2.33.
May 18 (New) (4 Marks)
Answer:
Assuming share prices are normally distributed, for level of 99%, the equivalent Z score from
Normal table of Cumulative Area is 2.33.
Volatility in terms of Rupee is

2% of ₹1 Crore = ₹2 Lakh
The maximum loss for 1 day at 99% Confidence level is
₹2 Lakh × 2.33 = ₹4.66 Lakhs,
and expected maximum loss for 10 trading days shall be:
√10 × ₹4.66 lakh = 14.74 Lakhs or 14.73 Lakhs.
Question 2
Suppose Mr. A holds ₹2 crore shares of X Ltd. Whose market price standard deviation is 2%
per day. Assuming 252 trading days a year, determine maximum loss level over the period of 1
trading day and 10 trading days with 99% confidence level.
StudyMat
Answer:
Assuming share prices are normally distributed for level of 99%, the equivalent Z score from
Normal table of Cumulative Area shall be 2.33.
Volatility in terms of rupees shall be:
2% of ₹2 Crore = ₹4 lakh
The maximum loss for 1 day at 99% Confidence Level shall be:
₹4 lakh × 2.33 = ₹9.32 lakh,
and expected maximum loss for 10 trading days shall be:
√10 × ₹9.32 lakh = ₹29.47 lakhs
1
Question 3
The VAR on portfolio using a one day horizon is USD 100 million. What is the VAR using a 10
day horizon?
Answer:
• 10% chance of losing atleast $100 millions in 1 day.
• 90% chances that maximum loss will be $100 million in 1 day.
VAR10 days = Z Score × SD10 days
= Z score × SD1 × ඥ10
VAR10 days = VAR1 day × ඥ10 = 100 × ඥ10 = 100 × 3.162
VAR10 days = $316.23 millions
Interpretation: If 90% is confidence interval it seems that we have
• 10% chance of losing $316.23 millions in 10 days horizon
• 90% chance of losing maximum $316.23 millions in 10 days horizon
Question 4
Consider a portfolio of $5 million on AT & T shares with a daily volatility of 1%. Calculate the
99% VAR for 10 days horizon.
Answer:
VAR10 days = Z Score × SD10 days
= Z score × SD1 day × √t
= 2.33 × 50,000 × √10
= 2.33 × 50,000 × 3.16
VAR10 days = $3,68,140
1% chance of losing at least $368140 in 10 days Horizon.
Question 5
Suppose we have a portfolio of $10 million in shares of Microsoft. We want to calculate VAR at
99% confidence interval over a 10 day horizon. The volatility of Microsoft is 2% per day.
Calculate VAR
Answer:
Investment = $1,00,00,000
SD = 2%/day
VAR10 days = VAR1 day × √t
= SD1 day × Z Score × √t
= 2,00,000 × 2.33 × √10
= $4,66,000 × 3.16
VAR10 days = $14,72,500
2
Question 6
If the daily VAR is $12,500, calculate the weekly, monthly, semi-annually and annual VAR.
Assume 250 days and 50 weeks per year.
Answer:
VARt days = VAR1 day × √t
(a) Weekly (250/50)

VAR5 days = VAR1 day × √5 = $12,500 x 2.236 = $27,950
(b) Monthly (250/12)

VAR21 days = VAR1 day × √21 = $12500 × 4.583 = $57,287
(c) Semi Annual (250/2)

VAR125 days = VAR1 day × √125 = $12500 × 11.180 = $139,750
(d) Annual (250/1)

VAR250 days = VAR1 day × √250 = $12500 × 15.811 = $197,638
Question 7
James has estimated an annual standard deviation of $750,000 on one of its projects, based on
a normal distribution of returns. The average annual return is $2,400,000. Estimate the value at
risk (VAR) at a 95% confidence level for one year and over the project’s life of six years.
Answer:
(a) VAR1 year = Z Score × SD1 year
= 1.65 × 750000
VAR1 year = $1237500
5% of the time we will lose at least $1237500 in a year.
(b) VAR6 years = Z Score × SD6 years

= 1.65 × 750000 × 2.45
VAR6 year = $3031875
5% of the time we will lose at least $13031875 in 6 years.
3
Question 8
A trader has an allocation equal to 8% of the firm’s capital. The returns of this unit have a beta
with respect to overall returns of 0.9. The firm’s daily VAR is $120 million. What should be the
VAR allocated to trader’s unit?
Answer:
Capital Beta Returns VaR
Firm $1000 1 10% $120 million
Trader $80 0.9 9% ?
VARtrader = VARFirm × Share Allotted × Beta

= 120 × 8% × 0.9
= $9.60 × 0.90
VARtrader = $8.64 million
Trader Beta VaRtrader
1 9.60
0.90 8.64
Question 9
Following is the information about Mr. J's portfolio:
Investment in shares of ABC Ltd. ₹200 lakh
Investment in shares of XYZ Ltd. ₹200 lakh
Daily standard deviation of both shares 1%
Co-efficient of correlation between both shares 0.3
Required:
Determine the 10 days 99% Value At Risk (VAR) for Mr. J's portfolio. Given: The Z score from
the Normal Table at 99% confidence level is 2.33. (Show your calculations up to four decimal
points).
Nov 19 (New) (4 Marks)
Answer:
VARPortfolio = SDPortfolio × Z Score × √t
= 3.22 × 2.33 × ඥ10
VARPortfolio = ₹23.73 Lakhs ---10 Days
SD = ඥVariance of Portfolio
4
VarianceP ሺ₹ሻ = ሺσXYZ WXYZ ሻ2 +ሺσABC WABC ሻ2 +2σXYZ × WXYZ σABC WABC rXA
VarianceP (%) = σ2XYZ +σ2ABX +2σXYZ σABC rXA
VarianceP = σ2XYZ +σ2ABX +2σXYZ σABC rXA
= 22 +22 +2 × 2 × 2 × 0.3
= 4+4+2.4
VarianceP = 10.4
SDP = ඥ10.4 = 3.22
Question 10
Consider a position consisting of a $100,000 investment in asset A and a $100,000 investment
in asset B. Assume that the daily volatilities of both assets are 1% and that the coefficient of
correlation between their returns is 0.3. What is the 5-day 99% value at risk for the portfolio?
Answer:
A = 100000 × 1% = $1000
B = 100000 × 1% = $1000
r = 0.3
VAR5 = VAR1 × √t = SD1 × Z Score × √5
2 2
Variance = [SD1 ] +[SD2 ] +2 × r × SD1 × SD2
= ሾ1000ሿ2 +ሾ1000ሿ2 +2 × 0.3 × 1000 × 1000
= 1000000+1000000+600000
= 2600000
SD = $1612.45
VAR5 = VAR1 × √t
= SD1 × Z Score × √5
= $1612.45 × 2.33 × 2.24
= $3757 × 2.24
VAR5 = $8415.70
5
Question 11
The Westover Fund is a portfolio consisting of 42% fixed- income investments and 58% equity
investments. The manager of the Westover Fund recently estimated that the annual VAR (5%),
assuming a 250-day year, for the entire portfolio was $1,367,000 based on the portfolio’s market
value of $12,428,000 and a co-relation coefficient between stocks and bonds of zero.
If the annual loss in the equity position is only expected to exceed $1,153,000; 5% of the time,
then the daily expected loss in the bond position that will be exceeded 5% of the time will be
closest to which number?
Answer:
VAR2P = VAR2E +VAR2B +2VARE VARB rEB
2 2
(1.367) = (1.153) +VAR2B +0
1.8687 = 1.3294+VAR2B
VARB = ඥ0.5393
VARB = $0.73437 millions ---Annual VAR
VAR250 days = VAR1 day × ඥ250

0.73437 = VAR1 day × 15.811
VAR1 day = $0.04645 millions or $46450
Question 12
Consider a portfolio with two foreign currencies, Canadian dollar and euro. These two currencies
are uncorrelated and have volatility against the dollar of 5% and 12% respectively. The portfolio
has $2 million invested in CAD and $1 million in Euro. What is the portfolio VAR at 95%
confidence level? What is the impact of diversification? Suppose we increase the Canadian
dollar position by $10,000. What is the marginal VAR?
Answer:
(a) VARCAD = SDCAD × Z Score
= 5% × 2 × 1.65
= 0.1 × 1.65
= $0.165 millions or $165000
VAREUR = SDEUR × Z Score

= 12% × 1 × 1.65
= 0.12 × 1.65
= $0.198 millions or $198000
6
VAR2P = VAR2CAD +VAR2EUR +2VARCAD VAREUR rCADEUR

= 0.1652 +0.1982 +0
= 0.027225+0.039204+0
= 0.066429
VARP = $0.257738 or $257738
Alternatively,
VARP = SDP × Z Score
= 0.1562 × 1.65
= $0.25773 or $257730
SDP = ඥVariance of Portfolio = 0.1562
σ2P = σ2CAD +σ2EUR +2σCAD σEUR rCADEUR

= ሺ0.10ሻ2 +ሺ0.12ሻ2 +0
= 0.01+0.0144
= 0.0244
σP = 0.1562
(b) If there is no diversion VAR of portfolio will simply be the total VAR of two currencies i.e.
165000 + 198000 = $363000
But actual VAR of portfolio is $257730
It means that diversification has resulted into risk reduction.
(c) Marginal VAR = New VARP -Old VARP

= 258623-257730
Marginal VAR = $893
New VAR2P = VAR2CAD +VAR2EUR +0

= ሺSDCAD × Z Scoreሻ2 +ሺ0.198ሻ2
= ሺ5% × 2.01 × 1.65ሻ2 +ሺ0.198ሻ2
= ሺ0.165825ሻ2 +ሺ0.198ሻ2
= 0.0275+0.0392
VAR2P = 0.0667
VARP = $0.258263 or $258263
7
Question 13
On Tuesday morning (before opening of the capital market) an investor, while going through his
bank statement, has observed that an amount of ₹7 lakhs is lying in his bank account. This
amount is available for use from Tuesday till Friday. The Bank requires a minimum balance of
₹1000 all the time. The investor desires to make a maximum possible investment where Value
at Risk (VaR) should not exceed the balance lying in his bank account. The standard deviation
of market price of the security is 1.5 per cent per day. The required confidence level is 99 per
cent.
Given
Standard Normal Probabilities
z 0.00 .01 .02 .03 0.04 .05 .06 .07 .08 .09
2.2 .9861 .9864 .9868 .9871 .9875 .9878 .9881 .9884 .9887 .9890
2.3 .9893 .9896 .9998 .9801 .9904 .9906 .9909 .9911 .9913 .9916
2.4 .9918 .9920 .9922 .9923 .9925 .9929 .9931 .9932 .9934 .9936
You are required to determine the maximum possible investment.

Answer:
Particulars Amount (₹)
Amount available in bank account 7,00,000
Minimum balance to be kept 1,000
Available amount which can be used for potential investment for 4 days 6,99,000
Maximum Loss for 4 days at 99% level 6,99,000
Maximum Loss for 1 day at 99 % level = Maximum Loss for 4 days / 3,49,500
ඥNo. of days = 699000/√4
Z Score at 99% Level 2.33
Volatility in terms of Rupees (Maximum Loss/ Z Score at 99% level) 1,50,000
= 349500/ 2.33
Maximum Possible Investment (Volatility in Rupees/ Std. Deviation) 1,00,00,000
= 150000/.015
8
Question 14
ABC Ltd. is considering a project X, which is normally distributed and has mean return of ₹2
crore with Standard Deviation of ₹1.60 crore.
In case ABC Ltd. loses on any project more than ₹1.00 crore there will be financial difficulties.
Determine the probability the company will be in financial difficulty.
Given: Standard Normal Distribution Table (Z-Score) providing area between Mean and Z
score
Z Score Area
1.85 0.4678
1.86 0.4686
1.87 0.4693
1.88 0.4699
1.89 0.4706
MTP April 21 (4 Marks)
Answer:
For calculating probability of financial difficulty, we shall calculate the area under Normal
Curve corresponding to the Z Score obtained from the following equation (how many SD
is away from Mean Value of financial difficulty):
x-μ
z=
σ
-1.00 crore - 2.00 crore
=
1.60 crore
= -1.875
Corresponding area from Z Score Table by using interpolation shall be found as follows:
Z Score Area under Normal Curve
1.87 0.4693
1.88 0.4699
0.01 0.0006
0.0006
The corresponding value of 0.005 Z score =0.005 × =0.0003
0.01
Thus the Value of 1.875 shall be = 0.4693 + 0.0003 = 0.4696

And the value of -1.875 shall be = 0.50 – 0.4696 = 0.0304
Thus the probability the company shall be in financial difficulty is 3.04%.
9
CA Mayank Kothari 3. Security Analysis
CHAPTER 3
SECURITY ANALYSIS
Question 1
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 200X
were as follows:
Days Date Day Sensex
1 6 THU 29522
2 7 FRI 29925
3 8 SAT No Trading
4 9 SUN No Trading
5 10 MON 30222
6 11 TUE 31000
7 12 WED 31400
8 13 THU 32000
9 14 FRI No Trading
10 15 SAT No trading
11 16 SUN No trading
12 17 MON 33000
Compute Exponential Moving Average (EMA) of Sensex during the above period. The 30 days
simple moving average of Sensex can be assumed as 30,000. The value of exponent for 30
days EMA is 0.062.
Provide detailed analysis on the basis of your calculations.
Answer:
EMA =Previous EMA+ [(CP-Previous EMA) x e] or
EMA = [CP x e]+ [Previous EMA x (1-e)]
Date 1 2 3 = 1-2 4 = 3 × 0.062 5 = EMA (2 + 4)

Sensex EMA for Previous day
6 29522 30000 (478) (29.636) 29970.364
7 29925 29970.364 (45.364) (2.812) 29967.55
10 30222 29967.55 254.45 15.776 29983.32
10
11 31000 29983.32 1016.68 63.034 30046.354

12 31400 30046.354 1353.646 83.926 30130.28
13 32000 30130.28 1869.72 115.922 30246.202
17 33000 30246.202 2753.798 170.735 30416.937
Conclusion – The market is bullish. The market is likely to remain bullish for short term to medium
term if other factors remain the same. On the basis of this indicator (EMA) the investors/brokers
can take long position.
Note: Value of Exponent if not given in question can be calculated as e =2/n+1 where n number days for which
EMA is calculated (30 days in this question)
Question 2
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 20xx
were as follows:
1 6 THU 34522
2 7 FRI 34925
3 8 SAT No Trading
4 9 SUN No Trading
5 10 MON 35222
6 11 TUE 36000
7 12 WED 36400
8 13 THU 37000
9 14 FRI No Trading
10 15 SAT No Trading
11 16 SUN No Trading
12 17 MON 38,000
Calculate Exponential Moving Average (EMA) of Sensex during the above period. The 30 days
days EMA is 0.064. Provide analyzed conclusion on the basis of your calculations.
(Calculations should be up to three decimal points.)
11
Answer:
1 2 3 4 5
Date Sensex EMA for Previous day 1-2 3 × 0.064 EMA 2 + 4
6 34522 35000 (478) (30.592) 34969.408
7 34925 34,969.408 (44.408) (2.842) 34966.566
10 35222 34966.566 255.434 16.348 34982.914
11 36000 34982.914 1017.086 65.094 35048.008
12 36400 35048.008 1351.992 86.527 35134.535
13 37000 35134.535 1865.465 119.390 35253.925
17 38000 35253.925 2746.075 175.749 35429.674
Conclusion – The market is bullish. The market is likely to remain bullish for short term to
medium term if other factors remain the same. On the basis of this indicator (EMA) the
investors/brokers can take long position.
Note: Value of Exponent if not given in question can be calculated as e =2/n+1 where n number days for which
EMA is calculated (30 days in this question)
Question 3
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 200X
were as follows:
1 6 THU 14522
2 7 FRI 14925
3 8 SAT No Trading
4 9 SUN No Trading
5 10 MON 15222
6 11 TUE 16000
7 12 WED 16400
8 13 THU 17000
9 14 FRI No Trading
10 15 SAT No Trading
11 16 SUN No Trading
12 17 MON 18000
12
Calculate Exponential Moving Average (EMA) of Sensex during the above period. The 30 days
days EMA is 0.062.
Give detailed analysis on the basis of your calculations.
Nov 09 (6 Marks), RTP May 17, MTP Oct 17 (6 Marks), MTP March 18 (New) (7 Marks), May 18 (New) (8
Marks), Practice Manual, StudyMat
Answer:
Date 1 2 3 4 5
Sensex EMA for Previous day 1-2 3 × 0.062 EMA = 2 + 4
6 14522 15000 (478) (29.636) 14970.364
7 14925 14970.364 (45.364) (2.812) 14967.55
10 15222 14967.55 254.45 15.776 14983.32
11 16000 14983.32 1016.68 63.034 15046.354
12 16400 15046.354 1353.646 83.926 15130.28
13 17000 15130.28 1869.72 115.922 15246.202
17 18000 15246.202 2753.798 170.735 15416.937
Conclusion – The market is bullish. The market is likely to remain bullish for short term to
medium term if other factors remain the same. On the basis of this indicator (EMA) the
investors/brokers can take long position.
Note: Value of Exponent if not given in question can be calculated as e =2/n+1 where n number days for
which EMA is calculated (30 days in this question)
13
Question 4
The closing value of Sensex for the month of October, 2017 is given below:
Date Closing Sensex Value
1.10.17 2800
3.10.17 2780
4.10.17 2795
5.10.17 2830
8.10.17 2760
9.10.17 2790
10.10.17 2880
11.10.17 2960
12.10.17 2990
15.10.17 3200
16.10.17 3300
17.10.17 3450
19.10.17 3360
22.10.17 3290
23.10.17 3360
24.10.17 3340
25.10.17 3290
29.10.17 3240
30.10.17 3140
31.10.17 3260
ANALYZE the weak form of efficient market hypothesis by applying the run test at 5% and
10% level of significance using 18 Degrees of Freedom.
Note: Value of t at 5% is 2.101 at 18 Degrees of Freedom
Value of t at 10% is 1.734 at 18 Degrees of Freedom
MTP April 21 (12 Marks), Nov 08 (8 Marks), RTP May 12, MTP Mar 16 (8 Marks), MTP Oct 18 (New) (10
Marks), Practice Manual, StudyMat
Answer:
14
Date Closing Sensex Sign of Price Charge

1.10.11 2800
3.10.11 2780 -
4.10.11 2795 +
5.10.11 2830 +
7.10.11 2760 -
10.10.11 2790 +
11.10.11 2880 +
12.10.11 2960 +
13.10.11 2990 +
14.10.11 3200 +
17.10.11 3300 +
18.10.11 3450 +
19.10.11 3360 -
20.10.11 3290 -
21.10.11 3360 +
24.10.11 3340 -
25.10.11 3290 -
27.10.11 3240 -
28.10.11 3140 -
31.10.11 3260 +
Total of price changes (r) = 8

No. of Positive changes = n1 = 11
No. of Negative changes = n2 = 08
2n1 n2
μr = +1
n1 +n2
2 × 11 × 8
= +1
11+8
= 176/19+1
= 10.26
15
2n1 n2 (2n1 n2 -n1 -n2 )

σ^r = √ 2
σ^r
(n1 +n2 ) (n1 +n2 -1)
(2 × 11 × 8) (2 × 11 × 8-11- 8)
=√
ሺ11+ 8ሻ2 (11+8-1)
176 × 157
=√
ሺ19ሻ2 (18)
= ඥ4.252
= 2.06
Since too few runs in the case would indicate that the movement of prices is not random.
We employ a two- tailed test the randomness of prices.
Test at 5% level of significance at 18 degrees of freedom using the t-table.

The lower limit = μ-t × σ^r = 10.26-2.101 × 2.06 = 5.932
Upper limit = μ+t × σ^r = 10.26+2.101 × 2.06 = 14.588
At 10% level of significance at 18 degrees of freedom

Lower limit = 10.26 – 1.734 × 2.06 = 6.688
Upper limit = 10.26 + 1.734 × 2.06 = 13.832
As seen r lies between these limits. Hence, the market exhibits weak form of efficiency.
*For a sample of size n, the t distribution will have n-1 degrees of freedom.
Question 5
Mr. X is of the opinion that market has recently shown the Weak Form of Market Efficiency. In
order to test the validity of his impression he has collected the following data relating to the
movement of the SENSEX for the last 20 days.
Days Open High Low Close
1 33470.94 33513.79 33438.03 33453.99
2 33453.64 33478.11 33427.82 33434.83
3 33414.06 33440.29 33397.65 33431.93
4 33434.94 33446.18 33377.78 33383.41
5 33372.92 33380.27 33352.12 33370.93
6 33375.85 33389.49 33331.42 33340.75
16
7 33340.89 33340.89 33310.95 33330.98

8 33326.84 33340.91 33306.17 33335.08
9 33307.16 33328.22 33296.43 33301.97
10 33298.64 33318.60 33254.28 33259.03
11 33260.04 33228.85 33241.66 33251.53
12 33255.92 33289.46 33249.46 33285.89
13 33288.86 33535.67 33255.98 33329.28
14 33335.00 33346.21 33276.72 33284.17
15 33293.83 33310.86 33278.54 33298.78
16 33300.02 33337.79 33300.02 33325.38
17 33323.36 33356.34 33322.44 33329.95
18 33322.81 33345.98 33317.44 33319.67
19 33317.51 33321.18 33294.19 33302.32
20 33290.86 33324.96 33279.62 33319.61
You are required:

To test the Weak Form of Market Efficiency using Auto-Correlation test, taking time lag of 10
days.
Jan 21 (New) (8 Marks)
Answer:
Period 1 Closing Prices Change Period 2 Closing Prices Change
1 33453.99 11 33251.53
2 33434.83 -19.16 12 33285.89 34.36
3 33431.93 - 2.90 13 33329.28 43.39
4 33383.41 - 48.52 14 33284.17 - 45.11
5 33370.93 - 12.48 15 33298.78 14.61
6 33340.75 - 30.18 16 33325.38 26.6
7 33330.98 -9.77 17 33329.95 4.57
8 33335.08 4.1 18 33319.67 -10.28
9 33301.97 - 33.11 19 33302.32 -17.35
10 33259.03 - 42.94 20 33319.61 17.29
X Y X2 Y2 XY
-19.16 34.36 367.11 1180.61 -658.34
-2.90 43.39 8.41 1882.69 -125.83
-48.52 -45.11 2354.19 2034.91 2188.74
17
-12.48 14.61 155.75 213.45 -182.33

-30.18 26.6 910.83 707.56 -802.79
-9.77 4.57 95.45 20.88 -44.65
4.1 -10.28 16.81 105.68 -42.15
-33.11 -17.35 1096.27 301.02 574.46
-42.94 17.29 1843.84 298.94 -742.43
∑ X =-194.96 ∑ Y =68.08 ∑ X2 =6848.66 ∑ Y2 =6745.74 ∑ XY =164.68

̅ =-21.66
X ̅ =7.56
Y
̅̅̅̅
∑ XY- nXY
b=
̅ )2
∑ X2 - n(X
164.68 - 9(-21.66)(7.56)
= 2
6848.66-9(-21.66)
=0.624
̅ -bX
a=Y ̅
=7.56 – 0.624(-21.66)
= 21.08
2
̅)
a ∑ Y+b ∑ XY- n(Y
2
r =
̅ )2
∑ Y2 -n (Y
2
21.08(68.08) + 0.624(164.68) - 9(7.56)
= 2
6745.74 - 9(7.56)
r2 =0.164
r=0.405
There is moderate degree of correlation between the returns of two periods hence it can
be concluded that the market does not show the weak form of efficiency.
18
CA Mayank Kothari 4. Security Valuation
CHAPTER 4
SECURITY VALUATION
Question 1
Goldilocks Ltd. was started a year back with equity capital of ₹40 lakhs. The other details are as
under:
Earnings of the company ₹4,00,000
Price Earnings ratio 12.5
Dividend paid ₹3,20,000
Number of Shares 40,000
Find the current market price of the share. Use Walter's Model
MTP Nov 21 (Old) (8 Marks), Nov 14 (5 Marks), Practice Manual
Answer:
Goldilocks Ltd.
Walter’s model is given by
D+ሺE-Dሻ(r/Ke )
P=
Ke
Where,
P = Market price per share.
E = Earnings per share = ₹10
D = Dividend per share = ₹8
r = Return earned on investment = 10%
Ke = Cost of equity capital = 1/12.5 = 8%
0.10 0.10
8+ሺ10-8ሻ × 8+2 ×
P= 0.08 = 0.08 = ₹131.25
0.08 0.08
Question 2
X Ltd. earns ₹6 per share having a capitalization rate of 10 percent and has a return on
investment of 20%. According to Walter's model, what should be the price of the share at 25%
dividend payout?
Nov 12 (5 Marks), MTP Sept 16 (5 Marks)
Answer:
Walter Model is as follows:-
19
Ra
D+ ሺE-Dሻ
Rc
Ve =
Rc
Ve = Market value of the share

Ra = Return on retained earnings
Re = Capitalization rate
E = Earnings per share
D = Dividend per share
Hence, if Walter model is applied-

Market value of the share VC
0.20
₹1.50+ ሺ₹6.00-₹1.50ሻ
= 0.10
0.10
0.20
₹1.50+ ሺ₹4.50ሻ
= 0.10
0.10
₹1.50+₹9.00
=
0.10
₹10.50
=
0.10
= ₹105
Question 3
You are requested to find out the approximate dividend payment ratio as to have the Share Price
at ₹56 by using Walter Model, based on following information available for a Company.
Amount ₹
Net Profit 50 lakhs
Outstanding 10% Preference Shares 80 lakhs
Number of Equity Shares 5 lakhs
Return on Investment 15%
Cost of Capital (after Tax) (Ke) 12%
Practice Manual
Answer:
20
(i)
₹ in lakhs
Net Profit 50
Less: Preference dividend 8
Earning for equity shareholders 42
Therefore earning per share ₹42 lakhs / 5 lakhs = ₹8.40
(ii) Cost of capital i.e. (Ke) 12%

Let, the dividend payout ratio be X and so the share price will be:
r(E-D)
D Ke
P= + where D = Dividend (₹) and r = 15 % and Ke = 12%.
Ke Ke
Here D = 8.40x; E = ₹8.40; r = 0.15 and Ke = 0.12 and P = ₹56

8.40x 0.15(8.40-8.40x)
Hence, ₹56 = +
0.12 0.12 × 0.12
Or, ₹56 = 70X + 87.50 (1 –x)
-17.50x = -31.50
x = 1.80
Dividend Pay-out ratio would be zero, as pay-out is more than 100% of EPS seems to
be illogical.
Question 4
Summit Ltd., an All Equity Company, has a PAT of ₹300 Crores and 15,00,000 Shares of ₹10
each outstanding at the end of financial year. Its Cost of Capital is 13% and Rate of Return is
17%. Ascertain the value of the Company under Walter’s Model, if payout ratio is (a) 15%, (b)
30%, (c) 60%, and (d) 90%. Also draw out the inference from the values obtained under different
cases.
Nov 20 (Old) (5 Marks)
Answer:
Walter’s model is given by
D+(E-D)(r/Ke )
P=
Ke
Where,
P = Market price per share.
21

r = Return earned on investment
Ke = Cost of equity capital
EPS = PAT/ No. of shares = ₹300 Crores/ 15,00,000 = ₹2,000
(i) Value of the Company if payout ratio is 15%
0.17 0.17
300+(2000-300) × 300+1700 ×
P= 0.13 = 0.13 = ₹19,408.28
0.13 0.13
Value of Summit Ltd. = ₹19,408.28 × 15,00,000 = ₹2,911.2420 Crores
(ii) Value of the Company if payout ratio is 30%
0.17 0.17
600+(2000-600) × 600+1400 ×
P= 0.13 = 0.13 = ₹18,698.22
0.13 0.13
(iii) Value of the Company if payout ratio is 60%

0.17 0.17
1200+(2000-1200) × 1200+800 ×
P= 0.13 = 0.13 = ₹17,278.10
0.13 0.13
(iv) Value of the Company if payout ratio is 90%

0.17 0.17
1800+(2000-1800) × 1800+200 ×
P= 0.13 = 0.13 = ₹15,857.99
0.13 0.13
Decision: With the increase in payout ratio, the value of company is decreasing.
22
Question 5
The following information pertains to M/s XY Ltd.
Earnings of the Company ₹5,00,000
Dividend Payout ratio 60%
No. of shares outstanding 1,00,000
Equity capitalization rate 12%
Rate of return on investment 15%
(i) What would be the market value per share as per Walter’s model?
(ii) What is the optimum dividend payout ratio according to Walter’s model and the market
value of Company’s share at that payout ratio?
RTP May 16, Practice Manual
Answer:
(a) M/s XY Ltd.
(i) Walter’s model is given by
D+(E-D)(r/ke )
P=
ke
Where,
P = Market price per share
E = Earnings per share = ₹5
D = Dividend per share = ₹3
r = Return earned on investment = 15%
ke Cost of equity capital = 12%
P = 0.15 0.15
3+(5-3) × 3+2 ×
0.12 = 0.12
0.12 0.12
= ₹45.83
(ii) According to Walter’s model when the return on investment is more than the cost of
equity capital, the price per share increases as the dividend pay-out ratio decreases.
Hence, the optimum dividend pay-out ratio in this case is nil.
So, at a pay-out ratio of zero, the market value of the company’s share will be:
0.15
0+(5-0)
MP = 0.12 = ₹52.08
0.12
23
Question 6
The following information is supplied to you:
₹
Total Earnings 2,00,000
No. of equity shares (of ₹100 each) 20,000
Dividend paid 1,50,000
Price/Earning ratio 12.5
(i) Ascertain whether the company is the following an optimal dividend policy.
(ii) Find out what should be the P/E ratio at which the dividend policy will have no effect on
the value of the share.
(iii) Will your decision change, if the P/E ratio is 8 instead of 12.5?
RTP Nov 12, Practice Manual
Answer:
(i) The EPS of the firm is ₹10 (i.e.,₹2,00,000/20,000). The P/E Ratio is given at 12.5 and
the cost of capital, Ke, may be taken at the inverse of P/E ratio. Therefore, Ke is 8 (i.e.,
1/12.5). The firm is distributing total dividends of ₹1,50,000 among 20,000 shares,
giving a dividend per share of ₹7.50. the value of the share as per Walter’s model may
be found as follows:
D (r/Ke )(E-D) 7.50 ሺ0.10/.08ሻሺ10-7.5ሻ
P= + = + = ₹132.81
Ke Ke 0.08 0.08
The firm has a dividend payout of 75% (i.e.,₹1,50,000) out of total earnings of
₹2,00,000. since, the rate of return of the firm, r, is 10% and it is more than the Ke of
8%, therefore, by distributing 75% of earnings, the firm is not following an optimal
dividend policy. The optimal dividend policy for the firm would be to pay zero dividend
and in such a situation, the market price would be
D (r/Ke )(E-D) 0 ሺ0.10/.08ሻሺ10-0ሻ
P= + = + = ₹156.25
Ke Ke 0.08 0.08
So, theoretically the market price of the share can be increased by adopting a zero
payout.
(ii) The P/E ratio at which the dividend policy will have no effect on the value of the share
is such at which the Ke would be equal to the rate of return, r, of the firm. The Ke would
be 10% (= r) at the P/E ratio of 10. Therefore, at the P/E ratio of 10, the dividend policy
would have no effect on the value of the share.
24
(iii) If the P/E is 8 instead of 12.5, then the Ke which is the inverse of P/E ratio, would be
12.5 and in such a situation Ke > r and the market price, as per Walter’s model would
be
D (r/Ke )(E-D) 7.50 ሺ0.10/0.125ሻሺ10-7.5ሻ
P= + = + = ₹76
Ke Ke 0.125 0.125
The optimal dividend policy for the firm would be to pay 100% dividend and market
price of share in such case would be
10.0 (0.1/0.125)(10-10)
P= + = ₹80
0.125 0.125
Question 7
The following information relates to Maya Ltd:
Earnings of the company ₹10,00,000
Dividend payout ratio 60%
No. of Shares outstanding 2,00,000
Rate of return on investment 15%
(i) What would be the market value per share as per Walter’s model?
(ii) What is the optimum dividend payout ratio according to Walter’s model and the market
value of company’s share at that payout ratio?
Nov 10 (8 Marks), RTP May 13, RTP Nov 14, Practice Manual
Answer:
MAYA Ltd.
(i) Walter’s model is given by –
D+(E-D)(ROI/Ke )
P=
Ke
Where, P = Market price per share,
E = Earnings per share ₹5
D = Dividend per share ₹3
ROI = Return earned on investment 15%
ke = Cost of equity capital 12%
0.15 0.15
3+(5-3) × 3+2 ×
P= 0.12 = 0.12 = ₹45.83
0.12 0.12
(ii) According to Walter’s model when the return on investment is more than the cost of
equity capital, the price per share increases as the dividend pay-out ratio decreases.
Hence, the optimum dividend pay-out ratio in this case is Nil. So, at a payout ratio of
zero, the market value of the company’s share will be:-
25
0.15
0+(5-0) ×
0.12 = ₹52.08
0.12
Question 8
X Ltd has an internal rate of return @ 20%. It has declared dividend @ 18% on its equity shares,
having face value of ₹10 each. The payout ratio is 36% and Price Earning Ratio is 7.25. Find
the cost of equity according to Walter's Model and hence determine the limiting value of its
shares in case the payout ratio is varied as per the said model.
Practice Manual
Answer:
Internal Rate of Return (r) = 0.20
Dividend (D) = 1.80
1.80
Earnings Per ShareሺEሻ = =5
0.36
Price of ShareሺPሻ = 5 × 7.25 = 36.25
r
D+ (E-D)
ke
P=
ke
0.20
1.80+ (5-1.80)
ke
36.25 =
ke
0.20ሺ3.20ሻ
36.25 = 1.80+
ke
0.64
36.25 = 1.80+
ke
36.25k2e = 1.80ke +0.64
-b±ඥb2 -4ac
ke =
2a
2
-1.80±√(1.80) -4(-36.25) × 0.64 -1.80±√3.24+92.80
ke = = = 16%
2 × (-36.25) -72.50
Alternatively, it can also be calculated as follows:

36.25 ke 2 – 1.80 ke – 0.64 = 0
Taking 36.25 common
ke2 – 0.05 ke – 0.0176 = 0
26
ke2 – 0.16 ke + 0.11 ke – 0.0176 = 0

ke (ke – 0.16) + 0.11 (ke – 0.16) = 0
(ke + 0.11) (ke – 0.16) = 0
Since ke = -0.11 is not possible, the possible answer shall be ke = 0.16 i.e. 16%. Since the
firm is a growing firm, then 100% payout ratio will give limiting value of share
0.20
5.00+ (5-5) 5.00
P= 0.16 = = ₹31.25
0.16 0.15
Thus limiting value is ₹31.25

Alternatively, 0% payout ratio gives limiting value of shares as follows:
0.20
0+ (5-0) 1
P= 0.16 = = ₹39.06
0.16 2
(0.16)
Thus limiting value is ₹39.06
Question 9
S Ltd. earns ₹6 per share having capitalization rate of 10 per cent and has a return on investment
at the rate of 20 per cent. According to Walter’s model, what should be the price per share at 30
per cent dividend payout ratio? Is this the optimum payout ratio as per Walter?
MTP Aug 16 (5 Marks), MTP Oct 20 (Old) (4 Marks)
Answer:
Ra
D+ (E-D)
Rc
Walter Model isVc =
Rc
Where,
Vc = Market value of the share
Ra = Return on Retained earnings
Rc = Capitalisation Rate
Hence, if Walter model is applied
Market Value of the Share

0.20
1.80+ ሺ6-1.80ሻ
= 0.10
0.10
27
0.20
1.80+ ሺ4.20ሻ
= 0.10
0.10
1.80+8.40
=
0.10
= ₹102
This is not the optimum payout ratio because Ra > Rc and therefore Vc can further go up
if payout ratio is reduced.
Question 10
A company had paid a dividend of ₹2.50 per share last year and its required rate of return for
equity investors is 20%. What will be the market price of the share at the end of the year, if
(a) There is no growth in dividend?
(b) Dividend grows at constant rate of 5% per annum in perpetuity?
(c) Constant dividend for first five years and then grows at constant rate of 5% per annum in
perpetuity ?
(d) Constant dividend for first five years and then shares is sold at the price of ₹20?
MTP March 16 (8 Marks)
Answer:
(a) If there is no growth in Dividend then market price of share should be:
D ₹2.50
P0 = = = ₹12.50
k 0.20
(b) If there is growth in Dividend @ 5% p.a. then market price of share should be:
D0 (1+g) ₹2.50(1+0.05)
P0 = = = ₹17.50
(k-g) (0.20-0.05)
(c) If constant dividend for first 5 years and thereafter Dividend grows @ 5% p.a.
then market price of share should be:
P0 = PV of Constant Dividend for first 5 years + PV of Share after 5 years with constant
growth of dividend in perpetuity
₹2.50 (1+ 0.05)
P0 = PVAF (20%, 5) × ₹2.50 + PVF (20%, 5) ×
(0.20 - 0.05)
₹2.50 (1+x0.05)
P0 = 2.991 × ₹2.50 + 0.402 ×
(0.20 - 0.05)
P0 = ₹7.48 + ₹7.04 = ₹14.52
(d) If constant dividend for first 5 years and thereafter share is sold at ₹20, then
market price of share should be:
28
P0 = PV of Constant Dividend for first 5 years + PV of Share after 5 years

P0 = PVAF (20%, 5) × ₹2.50 + PVF (20%, 5) × ₹20
P0 = 2.991 × ₹2.50 + 0.402 × ₹20
P0 = ₹7.48 + ₹8.04
P0 = ₹15.52
Question 11
Sandy Ltd. has a book value per share of ₹140.00. Its return on equity is 16% and follows a
policy of retaining 60 percent of its annual earnings. What is the price of its share now if the
opportunity cost of capital is 18 percent?
[Adopt perpetual growth model to arrive at the solution].
Nov 20 (Old) (5 Marks), Nov 11 (5 Marks), Practice Manual, StudyMat
Answer:
The company earnings and dividend per share after a year are expected to be:
EPS = ₹140 × 0.16 = ₹22.40
Dividend = 0.40 × 22.4 = ₹8.96
The growth in dividend would be:
g = 0.60 × 0.16 = 0.096
D1 8.96
P0 = = = ₹106.67
Ke -g 0.18-0.096
Question 12
Share of X Ltd. is expected to be sold at ₹36 with a dividend of ₹6 after one year. If required rate
of return is 20% then what will be the share price?
StudyMat
Answer:
The expected share price shall be computed as follows:
6 36
P0 = 1
+ 1
= ₹35
(1+0.20) (1+0.20)
29
Question 13
The following information pertains to Golden Ltd:
Profit before tax ₹75 crore
Tax rate 30%
Return on investment (ROI) 18%
Retention ratio 80%
Number of shares outstanding 75,00,000
The market price of the share of the company in the bull market was somewhere around ₹2100
per share. Advice, whether the share of the Golden Ltd. should be purchased or not. Further,
also suggest the form of Market prevalent as per EMH Theory.
Note: Use Gordon’s Growth Model.
RTP May 21 (Old)
Answer:
Gordon’s Formula
P0 = E(1-b)
K-br
P0 = Market price per share
E = Earnings per share (₹52.50 crore / 75,00,000) = ₹70
K = Cost of Capital = 15%
b = 80%
D = ₹70 × 0.20 = ₹14
r = IRR = 18%
br = Growth Rate (0.80 × 18%) = 14.4%
P0 = 70(1-0.80) 14
=
0.15-0.144 0.006
= ₹2333.33
Advice: Despite the fact that market price of share of the company during bull was around
₹2200, it is worth to purchase the same as intrinsic value of share is higher than market
price even in bull phase.
The form of market is weak form of market as it is not discounting all information.
30
Question 14
The following information is given for QB Ltd.
Earnings per share ₹ 12
Dividend per share ₹3
Cost of capital 18%
Internal Rate of Return on investment 22%
Retention Ratio 75%
Calculate the market price per share using
(i) Gordon’s formula
(ii) Walter’s formula
RTP Nov 20 (Old), May 11 (8 Marks), Practice Manual
Answer:
(i) Gordon’s Formula
EPS-Dividend Per Share ₹12-₹3
Retention Ratio = = = 0.75 i.e. 75%
EPS ₹12
E(1-b)
P0 =
K-br
P0 = Present value of Market price per share
K = Cost of Capital
b = Retention Ratio (%)
r = IRR
br = Growth Rate
12(1-0.75) 3
P0 = = = ₹200
0.18-(0.75 × 0.22) 0.18-0.165
(ii) Walter’s Formula

Ra 0.22
D+ (E-D) ₹3+ (₹12-₹3) ₹3+₹11
Rc 0.18
Vc = = = = ₹77.77
Rc 0.18 0.18
Vc = Market Price
Ra = IRR
Rc = Cost of Capital
31
Question 15
Given the following information:
Current Dividend ₹5.00
Discount Rate 10%
Growth rate 2%
(i) Calculate the present value of the stock.

(ii) Is the stock over valued if the price is ₹40, ROE = 8% and EPS = ₹3.00. Show your
calculations under the PE Multiple approach and Earnings Growth model.
Jan 21 Old (8 Marks), Nov 12 (8 Marks), MTP March 15 (5 Marks), Practice Manual, Study Mat
Answer:
5.00(1.02)
(i) Present Value of the stock:- V0 = = ₹63.75
0.10-0.02
(ii) Value of stock under the PE Multiple Approach
Particulars
Actual Stock Price ₹40.00
Return on equity 8%
EPS ₹3.00
PE Multiple (1/Return on Equity) = 1/8% 12.50
Market Price per Share ₹37.50
Since, Actual Stock Price is higher, hence it is overvalued.

Value of the Stock under the Earnings Growth Model
Particulars
Actual Stock Price ₹40.00
Return on equity 8%
EPS ₹3.00
Growth Rate 2%
Market Price per Share [EPS × (1+g)]/(Ke – g) ₹51.00
= ₹3.00 × 1.02/0.06
Since, Actual Stock Price is lower, hence it is undervalued.
32
Question 16
Shares of Voyage Ltd. are being quoted at a price-earning ratio of 8 times. The company retains
₹5 per share which is 45% of its Earning Per Share.
You are required to compute
(i) The cost of equity to the company if the market expects a growth rate of 15% p.a.
(ii) If the anticipated growth rate is 16% per annum, calculate the indicative market price with
the same cost of capital.
(iii) If the company's cost of capital is 20% p.a. & the anticipated growth rate is 19% p.a.,
calculate the market price per share.
May 11 (8 Marks), StudyMat
Answer:
(i) Cost of Capital
Retained earnings (45%) ₹5 per share
Dividend (55%) ₹6.11 per share
EPS (100%) ₹11.11 per share
P/E Ratio 8 times
Market price ₹11.11 × 8 = ₹88.88
Cost of equity capital
Div ₹6.11
=( × 100) +Growth% = × 100+15% = 21.87%
Price ₹88.88
(ii)
Dividend ₹6.11
Market Price = ( )= = ₹104.08 per share
Cost of Capitalሺ%ሻ- Growth Rateሺ%ሻ (21.87-16)%
(iii)
₹6.11
Market Price = = ₹611.00 per share
(20-19)%
Question 17
A firm had been paid dividend at ₹2 per share last year. The estimated growth of the dividends
from the company is estimated to be 5% p.a. Determine the estimated market price of the equity
share if the estimated growth rate of dividends (i) rises to 8%, and (ii) falls to 3%. Also find out
the present market price of the share, given that the required rate of return of the equity investors
is 15.5%.
Nov 09 (6 Marks), MTP May 20 (Old) (5 Marks), Practice Manual
Answer:
33
In this case the company has paid dividend of ₹2 per share during the last year. The growth
rate (g) is 5%. Then, the current year dividend (D1) with the expected growth rate of 5% will
be ₹2.10
The share price is = P0
D1 ₹2.10
= = = ₹20
ke -g 0.155-0.05
In case the growth rate rises to 8% then the dividend for the current year. (D1) would be ₹
2.16 and market price would be-
₹2.16
= = ₹28.80
0.155-0.08
In case growth rate falls to 3% then the dividend for the current year (D1) would be ₹ 2.06
and market price would be-
₹2.06
= = ₹16.48
0.155-0.03
So, the market price of the share is expected to vary in response to change in expected
growth rate is dividends.
Question 18
ABC Limited, just declared a dividend of ₹28.00 per share. Mr. A is planning to purchase the
share of ABC Limited, anticipating increase in growth rate from 8% to 9%, which will continue
for three years. He also expects the market price of this share to be ₹720.00 after three years.
You are required to determine:
(i) the maximum amount Mr. A should pay for shares, if he requires a rate of return of 13% per
annum.
(ii) the maximum price Mr. A will be willing to pay for share, if he is of the opinion that the 9%
growth can be maintained indefinitely and require 13% rate of return per annum.
(iii) the price of share at the end of three years, if 9% growth rate is achieved and assuming
other conditions remaining same as in (ii) above.
Note: Calculate rupee amount up to two decimal points and use PVF upto 3 decimal points.
RTP May 21 (New), RTP May 21 (Old), May 13, RTP Nov 18 (Old), RTP May 12, MTP Feb 14 (8 Marks),
MTP Sept 14 (8 Marks), MTP April 18 (Old) (8 Marks), MTP Oct 19 (New) (7 Marks), Practice Manual
Answer:
(i) Expected dividend for next 3 years.
Year 1 (D1) ₹28.00 (1.09) = ₹30.52
Year 2 (D2) ₹28.00 (1.09)2 = ₹33.27
34
Year 3 (D3) ₹28.00 (1.09)3 = ₹36.26
Required rate of return = 13% (ke)

Market price of share after 3 years = (P3) = ₹720
The present value of share
D1 D2 D3 P3
P0 = + + +
(1+ke ) (1+ke )2 (1+ke )3 (1+ke )3
30.52 33.27 36.26 720
P0 = + + +
(1+0.13) (1+0.13) (1+0.13) (1+0.13)3
2 3
P0 = 30.52(0.885) + 33.27(0.783) +36.26(0.693) +720(0.693)

P0 = 27.01 + 26.05 + 25.13 + 498.96
P0 = ₹577.15
(ii) If growth rate 9% is achieved for indefinite period, then maximum price of share should
Mr. A willing be to pay is
D1 ₹30.52 ₹30.52
P0 = = = = ₹763
(ke -g) 0.13-0.09 0.04
(iii) Assuming that conditions mentioned above remain same, the price expected after 3
years will be:
D4 D3 (1.09) 36.26 × 1.09 39.52
P3 = = = = = ₹988
(ke -g) 0.13-0.09 0.04 0.04
Question 19
Shares of Volga Ltd. are being quoted at a price-earning ratio of 8 times. The company retains
50% of its Earnings Per Share. The Company's EPS is ₹ 10.
1) the cost of equity to the company if the market expects a growth rate of 15% p.a.
2) the indicative market price with the same cost of capital and if the anticipated growth rate is
16% p.a.
3) the market price per share if the company's cost of capital is 20% p.a. and the anticipated
growth rate is 18% p.a.
May 11 (8 Marks), Nov 18 (New) (8 Marks), Nov 13 (8 Marks), Practice Manual, StudyMat,
Answer:
1) Cost of Capital
Retained earnings (50%) ₹5 per share
Dividend (50%) ₹5 per share
EPS (100%) ₹10 per share (given)
35
P/E Ratio 8 times (given)

Market price ₹10 × 8 = ₹80 per share
Div ₹5
Ke = ( × 100) +Growth % = × 100+15% = 21.25%
Price ₹80
2) Market Price
Dividend ₹5
MP = ( ) = = ₹95.24 per share
Cost of Capitalሺ%ሻ-Growth Rateሺ%ሻ ሺ21.25-16ሻ%
3) Market Price
Dividend ₹5
MP = ( ) = = ₹250 per share
Cost of Capitalሺ%ሻ-Growth Rateሺ%ሻ ሺ20-18ሻ%
Alternatively, if candidates have assumed the given figure of EPS as of last year then
answer will be as follows:
(1) Cost of Capital

Retained Earnings (50%) ₹5 per share
Dividend (50%) ₹5 per share
EPS (100%) ₹10 per share (given)
P/E Ratio 8 times (given)
Market price ₹10 × 8 = ₹80 per share
Div ₹5ሺ1.15ሻ
Ke = ( × 100) +Growth % = × 100+15% = 22.19%
Price ₹ 80
(2) Market Price

Dividend ₹5.85
MP = ( ) = = ₹94.51 per share
Cost of Capitalሺ%ሻ-Growth Rateሺ%ሻ ሺ22.19-16ሻ%
(3) Market Price

₹5ሺ1.18ሻ
MP = = ₹295 per share
ሺ20-18ሻ%
36
Question 20
A company has an EPS of ₹2.5 for the last year and the DPS of ₹1. The earnings is expected
to grow at 2% a year in long run. Currently it is trading at 7 times its earnings. If the required rate
of return is 14%, compute the following:
(i) An estimate of the P/E ratio using Gordon growth model.
(ii) The Long-term growth rate implied by the current P/E ratio.
Nov 18 (Old) (8 Marks), MTP May 20 (New) (6 Marks), MTP March 21 (Old) (5 Marks)
Answer:
(i) Estimation of P/E Ratio using Gordon Growth Model
D1
Ke = +g
P
1(1.02)
0.14 = +0.02
P
P = ₹8.50
₹8.50
PE Ratio = = 3.40
₹2.50
(ii) Long Term Growth Rate implied

Based on Current PE Ratio, the price per share
= ₹2.50 × 7 Times = ₹17.50
We know that,
P = D0(1 + g)/ (ke – g)
₹17.50 = ₹1(1 + g)/ (0.14 – g)
17.50 × 0.14 – 17.50g = 1 + g
g = 0.0784 i.e. 7.84%
Question 21
Calculate the implied Growth Rate and Return on Equity
Current stock price = ₹65
Next year’s dividend = ₹4
Capitalization rate = 12%
Earnings retention ratio = 50%
Answer:
37
According to Gordon’s Model

D1
MP0 =
Ke -g
4
65 =
0.12-g
4
0.12-g =
65
-g = 0.0615 – 12
g = 0.0585
g = 5.85%
g=b×r
0.0585 = 0.50 × r
r = 11.69%
Where, b = Retention, r = ROI (Retention on Equity)
Question 22
Following financial information’s are available of XP Ltd. for the year 2018:
Equity Share Capital (₹10 each) ₹200 Lakh
Reserves and Surplus ₹600 Lakh
10% Debentures (₹100 each) ₹350 Lakh
Total Assets ₹1200 Lakh
Assets Turnover Ratio 2 times
Tax Rate 30%
Operating Margin 10%
Dividend Payout Ratio 20%
Current Market Price per Equity Share ₹28
Required Rate of Return of Investors 18%
You are required to:
(i) Prepare Income Statement for the year 2018.
(ii) Determine its Sustainable Growth Rate.
(iii) Determine the fair price of the company's share using Dividend Discount Model.
(iv) Give your opinion on investment in the company's share at current price.
July 21 (New) (8 Marks), June 09 (6 Marks), Nov 12 (8 Marks), May 19 (New) (8 Marks), RTP May 16, RTP
Nov 11, RTP May 20 (Old), MTP March 16 (8 Marks), MTP Feb 16 (8 Marks), Practice Manual
38
Answer:
Workings:
Asset turnover ratio = 2 times
Total Assets = ₹1200 lakh
Turnover ₹1200 lakhs × 2 = ₹2400 lakhs
Interest on Debentures = 350 lakh × 10% = 35 lakhs
Operating Margin = 10%
Hence operating cost = (1 - 0.10) 2400 lakhs = ₹2160 lakhs
Dividend Payout = 20%
Tax rate = 30%
(i) Income statement

(₹Lakhs)
Sale 2400
Operating Exp 2160
EBIT 240
Interest 35
EBT 205
Tax @ 30% 61.5
EAT 143.5
Dividend @ 20% 28.7
Retained Earnings 114.8
(ii)
Net Worth = ₹200 lakh+₹600 lakhs = ₹800 lakhs
ROE PAT ₹143.5 lakhs
= = × 100 = 17.94%
NW ₹800 lakhs
= ROE (1- b)
SGR = Return on Equity (1- Dividend Pay-out Ratio)
= 0.1794ሺ1-0.20ሻ = 14.35%
39
(iii) Calculation of fair price of share using dividend discount model

Dividend ₹28.7lakhs
= = ₹1.435
20 lakhs
Growth Rate = 14.35%
Hence P0 Do ሺ1+gሻ ₹1.435(1+0.1435) ₹1.64
P0 = = = = ₹44.93
ke -g 0.18-0.1435 0.0365
(iv) Since the current market price of share is ₹28, the share is undervalued. Hence, the
investor should invest in the company.
Question 23
Following Financial data are available for PQR Ltd. for the year 2008:
(₹ in lakh)
8% debentures 125
10% bonds (2007) 50
Equity shares (₹10 each) 100
Reserves and Surplus 300
Total Assets 600
Assets Turnovers ratio 1.1
Effective interest rate 8%
Effective tax rate 40%
Operating margin 10%
Dividend payout ratio 16.67%
Current market Price of Share ₹14
Required rate of return of investors 15%

(i) Draw income statement for the year
(ii) Calculate its sustainable growth rate of earnings
(iii) Calculate the fair price of the Company's share using dividend discount model, and
(iv) What is your opinion on investment in the company's share at current price?
Nov 09 (6 Marks), MTP Feb 16 (8 Marks), RTP Nov 11, RTP May 16, RTP May 20 (Old), StudyMat
Answer:
40
Workings
Asset Turnover Ratio = 1.1
Total Assets = ₹600
Turnover ₹600 lakhs × 1.1 = ₹660 lakhs
Effective Interest Rate = Interest
= 8%
Liabilities
Liabilities = ₹125 lakhs + 50 lakhs = 175 lakh
Interest = ₹175 lakhs × 0.08 = ₹14 lakh
Operating Margin = 10%
Hence Operating Cost = (1 - 0.10) ₹660 lakhs = ₹594 lakh
Dividend Payout = 16.67%
Tax Rate = 40%
(i) Income Statement

(₹ Lakhs)
Sale 660
Operating Exp 594
EBIT 66
Interest 14
EBT 52
Tax @ 40% 20.80
EAT 31.20
Dividend @ 16.67% 5.20
Retained Earnings 26.00
(ii) SGR = ROE (1-b)
PAT
ROE = and
NW
NW = ₹100 lakh+₹300 lakh = 400 lakh
₹31.2 lakhs
ROE = × 100 = 7.8%
₹400 lakhs
0.078 × 0.8333
SGR = 0.078ሺ1-0.1667ሻ = 6.5% or = 6.95%
1-0.078 × 0.8333
41
(iii) Calculation of fair price of share using dividend discount model

D0 (1+g)
Po =
ke - g
₹5.2 lakhs
Dividends = = ₹0.52
₹10 lakhs
Growth Rate = 6.5% or 6.95%

Hence,
₹0.52ሺ1+0.065ሻ ₹0.5538 0.52ሺ1+0.0695ሻ 0.5561
P0 = = = ₹6.51 or = = ₹6.91
0.15-0.065 0.085 0.15-0.0695 0.0805
(iv) Since the current market price of share is ₹14, the share is overvalued. Hence the
investor should not invest in the company.
Question 24
AB Industries has Equity Capital of ₹12 Lakhs, total Debt of ₹8 Lakhs, and annual sales of ₹30
Lakhs. Two mutually exclusive proposals are under consideration for the next year. The details
of the proposals are as under:
Particulars Proposal no. 1 Proposal no. 2
Target Assets to Sales Ratio 0.65 0.62
Target Net Profit Margin (%) 4 5
Target Debt Equity Ratio (DER) 2:3 4:1
Target Retention Ratio (of Earnings) (%) 75 -
Annual Dividend (₹In Lakhs) - 0.30
New Equity Raised (₹in Lakhs) - 1
You are required to calculate sustainable growth rate for both the proposals.
Answer:
Sustainable Growth Rate under Proposal 1
Sales (Given) ₹ 30 Lakhs
Total Assets ₹30 Lakhs × 0.65 ₹ 19.50 Lakhs
Net Profit ₹30 Lakhs × 4% ₹ 1.20 Lakhs
Equity Multiplier Equity 12 Lakhs 0.6
=
Equity + Debt 12 Lakhs+8 Lakhs
42
ROE 1.20 Lakhs 3.69%

× 0.60 × 100
19.50 Lakhs
Sustainable Growth Rate = ROE × Retention Ratio = 3.69% × 0.75 = 2.77%
Sustainable Growth Rate under Proposal 2

New Equity = ₹12 Lakhs + ₹1 Lakh = ₹13 Lakhs
New Debt = ₹13 Lakhs × 4 = ₹52 Lakhs
Total Assets = ₹13 Lakhs + ₹52 Lakhs = ₹65 Lakhs
Target Assets to Sales Ratio (Given) 0.62

Sales ₹65 Lakhs / 0.62 ₹ 104.84 Lakhs
Net Profit ₹ 104.84 Lakhs × 5% ₹5.242 Lakhs
Equity Multiplier Equity 13 Lakhs 0.2
=
Equity + Debt 13 Lakhs+52 Lakhs
ROE 5.242 Lakhs × 0.20 × 100 1.613%
65 Lakhs
Retention Ratio 5.242 Lakhs-0.30 Lakhs 0.943
5.242 Lakhs
Sustainable Growth Rate = ROE × Retention Ratio = 1.613% × 0.943 = 1.52%
Question 25
In December, 2011 AB Co.'s share was sold for ₹146 per share. A long term earnings growth
rate of 7.5% is anticipated. AB Co. is expected to pay dividend of ₹3.36 per share.
(i) What rate of return an investor can expect to earn assuming that dividends are expected
to grow along with earnings at 7.5% per year in perpetuity?
(ii) It is expected that AB Co. will earn about 10% on book Equity and shall retain 60% of
earnings. In this case, whether, there would be any change in growth rate and cost of
Equity?
May 12 (6 Marks), RTP Nov 18 (Old), RTP Nov 20 (Old), MTP Oct 18 (Old) (8 Marks), MTP
Apr 19 (Old) (5 Marks), Practice Manual
Answer:
(i) According to Dividend Discount Model approach the firm’s expected or required
return on equity is computed as follows
D1
= +g
P0
43
Where,
ke = Cost of equity share capital
D1 = Expected dividend at the end of year 1
P0 = Current market price of the share.
g = Expected growth rate of dividend.
Therefore,
3.36
ke = +7.5% = 0.0230 +0.075 = 0.098 Or 9.80%
146
(ii) With rate of return on retained earnings (r) 10% and retention ratio (b) 60%, new growth
rate will be as follows:
g = br = 0.10 × 0.60 = 0.06 or 6%
Accordingly, dividend will also get changed and to calculate this, first we shall calculate
previous retention ratio (b1) and then EPS assuming that rate of return on retained
earnings (r) is same.
With previous Growth Rate of 7.5% and r = 10% the retention ratio comes out to be:
0.075 = b1 × 0.10
b1 = 0.75 and
Dividend payout ratio = 0.25
3.36
With 0.25 payout ratio the EPS will be as follows: = 13.44
0.25
With new 0.40 (1 – 0.60) payout ratio the new dividend will be D1 = 13.44 × 0.40 = 5.376
Accordingly, new ke will be =
5.376
ke = +6.0% = 9.68%
146
Alternatively,
EPS with 6% growth rate instead of 7.5%.
1.06
13.44 × = 13.25
1.075
With new 0.40 (1 – 0.60) payout ratio the new dividend will be D1 = 13.25 × 0.40 = 5.30
Accordingly,
New ke will be
5.30
ke = +6.0% = 9.63%
146
44
Question 26
Rahim Enterprises is a manufacturer and exporter of woolen garments to European countries.
Their business is expanding day by day and in the previous financial year the company has
registered a 25% growth in export business. The company is in the process of considering a new
investment project. It is an all equity financed company with 10,00,000 equity shares of face
value of ₹50 per share. The current issue price of this share is ₹125 ex-dividend. Annual
earning are ₹25 per share and in the absence of new investments will remain constant in
perpetuity. All earnings are distributed at present. A new investment is available which will cost
₹1,75,00,000 in one year’s time and will produce annual cash inflows thereafter of ₹50,00,000.
Analyse the effect of the new project on dividend payments and the share price.
MTP Oct 21 (Old) (5 Marks), Nov 17 (8 Marks), Practice Manual
Answer:
(a) Let us first compute the Cost of Equity
D 25
Ke = = = 20%
P 125
(b) Current Earning = ₹25 × 10,00,000 = ₹2,50,00,000
The new project can be financed by retaining ₹1,75,00,000 of ₹2,50,00,000
earning next year, reducing dividend payment to ₹75,00,000 or
₹75,00,000
= ₹7.50 per share
10,00,000
(c) In the following years, dividend will increase due to the cash generated by the new
project. Dividend per share in year 2 shall be:
₹2,50,00,000+₹50,00,000
= ₹30 per share
10,00,000
(d) The new share price can be calculated by finding the Present Value of the revised
dividend payments:
₹7.50 ₹30.00 1
P= + × = ₹131.25 per share
1.20 0.20 1.20
Question 27
NM Ltd. (NML) is aspiring to enter the capital market in a three years' time. The Board wants to
attain the target price of ₹70 for its shares at the end of three years. The present value of its
shares is ₹52.03. The dividend is expected to grow at a rate of 15% for the next three years.
NML uses dividend growth model for its projections.
The required rate of return is 15%.
45
You are required to calculate the amount of dividend to be declared by the board in the base
year so as to achieve the target price.
Period (t) 1 2 3
PVIF (15%, t) 0.8696 0.7561 0.6575
July 21 (Old) (5 Marks)
Answer:
PV of Share = PV of Dividends upto 3 years + PV of Target price of share after 3 years
₹52.03 = PV of Stream of Dividend upto 3 years + 70.00 × 0.6575
PV of Stream of Dividend upto 3 years = ₹52.03 – ₹ 46.03 = ₹6
Let Base Dividend is D0, then

₹6 = D0 (1+g) × PVIF (15%,1) + D0 (1 + g)2 PVIF (15%,2) + D0 (1+g)3 PVIF(15%,3)
₹6 = D0 (1.15) × 0.8696 + D0 (1.15)2 × 0.7561 + D0 (1.15)3 ×0.6575
₹6 = D0 + D0 + D0 = 3D0
D0 = ₹2
Thus, Company should declare a dividend of ₹ 2 in base year.
Question 28
MNP Ltd. has declared and paid annual dividend of ₹4 per share. It is expected to grow @ 20%
for the next two years and 10% thereafter. The required rate of return of equity investors is 15%.
Compute the current price at which equity shares should sell.
Note: Present Value Interest Factor (PVIF) @15%:
For year 1 = 0.8696;
For year 2 = 0.7561
May 14 (5 Marks), Practice Manual
Answer:
D0 = ₹4
D1 = ₹4 (1.20) = ₹4.80
2
D2 = ₹4 (1.20) = ₹5.76
2
D3 = ₹4 (1.20) (1.10) = ₹6.336
D1 D2 TV
P= + +
(1+ke) ሺ1+ke ሻ2 (1+ke )2
D3 6.336
TV = = = 126.72
ke -g 0.15 -0.10
4.80 5.76 126.72

P= + +
(1+ 0.15) (1+ 0.15) (1+ 0.15)2
2
46
= 4.80 × 0.8696 + 5.76 × 0.7561 + 126.72 × 0.7561

= 104.34
Question 29
M/s. B Ltd. has declared dividend of ₹2.50 per share on the EPS of ₹7. Earnings of the company
are expected to grow at the rate of 10% for the next 3 years and to be stabilized at 3% thereafter.
The pay-out ratio is expected to remain at the same level during 3 years and then will increase
to 60%. If required rate of return is 16%.
Calculate:
(i) The current price of the share.
(ii) The expected price of share of B Ltd. At the end of the 3rd year.
Following table may be used for calculations.
Present Values t1 t2 t3 t4 t5
PVIF0.16,t 0.862 0.743 0.641 0.553 0.477
Jan 21 (Old) (5 Marks)
Answer:
(i) Dividends for first three years
Period EPS Dividend
1 7.70 2.750
2 8.47 3.025
3 9.317 3.327
4th onwards 9.60 5.76
Expected price of share of B Ltd at end of 3rd year

5.76
=
0.16-0.03
= ₹44.31
Accordingly,
Current price of the Share
= PV of Dividends up to 3 Years + PV of Expected price of share of at the end of 3rd year
= 2.750 × 0.862 + 3.025 × 0.743 + 3.327 × 0.641 + 44.31 × 0.641
= 2.371 + 2.248 + 2.133 + 28.403
= ₹35.155 say ₹35.16
(ii)
5.76
Expected price of share of B Ltd. at the end of 3rd year = = ₹44.31
0.16-0.03
47
Question 30
The shares of G Ltd. we currently being traded at ₹46. The company published its results for the
year ended 31st March 2019 and declared a dividend of ₹5. The company made a return of 15%
on its capital and expects that to be the norm in which it operates. G Ltd. Also expects the
dividends to grow at 10% for the first three years and thereafter at 5%.
You are required to advise whether the share of the company is being traded at a premium or
discount.
PVIF @ 15% for the next 3 years is 0.870, 0.756 and 0.658 respectively.
Answer:
Expected dividend for next three years
Year 1 (D1) = 5 (1.1) = 5.5
Year 2 (D2) = 5.5 (1.1) = 6.05
Year 3 (D3) = 6.05 (1.1) = 6.655
Required Rate (Ke) = 15%

Present Value of Dividends
= 5.5 (0.870) + 6.05 (0.756) + 6.655 (0.658)
= 4.785 + 4.574 + 4.379
= 13.74
Now, PV at growth rate of 5%

D4 6.655(1.05) 6.988
P3 = = = = 69.88
Ke-g 0.15-0.05 0.1
Therefore, P0 = 69.88 × 0.658 = 45.98
Now, adding the PV of dividend at two different growth rates, we get,

13.74 + 45.98 = 59.72
Hence, it is clear that shares are being traded at discount i.e. undervalued because intrinsic
value of share is more than the market price.
Question 31
X Ltd. is a Shoes manufacturing company. It is all equity financed and has a paid-up Capital
of ₹10,00,000 (₹10 per share).
X Ltd. has hired Swastika consultants to analyse the future earnings. The report of Swastika
consultants states as follows:
(a) The earnings and dividend will grow at 25% for the next two years.
48
(b) Earnings are likely to grow at the rate of 10% from 3rd year and onwards.
(c) Further, if there is reduction in earnings growth, dividend payout ratio will increase to
50%.
The other data related to the company are as follows:
Year EPS (₹) Net Dividend per share (₹) Share Price (₹)
2010 6.30 2.52 63.00
2011 7.00 2.80 46.00
2012 7.70 3.08 63.75
2013 8.40 3.36 68.75
2014 9.60 3.84 93.00
You may assume that the tax rate is 30% (not expected to change in future) and post-tax cost
of capital is 15%.
By using the Dividend Valuation Model, calculate
(a) Expected Market Price per share
(b) P/E Ratio.
Nov 15 (6 Marks), MTP Mar 17 (8 Marks), MTP Oct 19 (Old) (8 Marks), RTP May 19 (Old),
RTP May 20 (Old), Practice Manual
Answer:
D1
(a) The formula for the Dividend valuation Model is P0 =
Ke -g
Ke = Cost of Capital
g = Growth rate
D1 = Dividend at the end of year 1
On the basis of the information given, the following projection can be made:
Year EPS (₹) DPS (₹) PVF @15% PV of DPS (₹)
12 4.8
2015 0.870 4.176
(9.60 × 125%) (3.84 × 125%)
15 6
2016 0.756 4.536
(12.00 × 125%) (4.80 × 125%)
16.5 8.25*
2017 0.658 5.429
(15.00 × 110%) (50% of ₹ 16.50)
14.141
*Payout Ratio changed to 50%.

After 2017, the perpetuity value assuming 10% constant annual growth is:
D1 = ₹8.25 × 110% = ₹9.075
49
₹9.075
Therefore, Po from the end of 2017 = = ₹181.50
0.15-0.10
This must be discounted back to the present value, using the 3 year discount factor
after 15%.
Present Value of P0 (₹181.50 × 0.658) 119.43
Add: PV of Dividends 2015 to 2017 14.14

Expected Market Price of Share 133.57
(b) P/E Ratio

Expected Market Price of Share(P1 ) ₹133.57
P/E Ratio = = = 13.91
EPS ₹9.60
Question 32
An investor is considering purchasing the equity shares of LX Ltd., whose current market price
(CMP) is 150. The company is proposing a dividend of ₹6 for the next year. LX is expected to
grow @ 18 per cent per annum for the next four years. The growth will decline linearly to 14 per
cent per annum after first four years. Thereafter, it will stabilize at 14 per cent per annum
infinitely. The required rate of return is 18 per cent per annum.
(i) The intrinsic value of one share
(ii) Whether it is worth to purchase the share at this price
t 1 2 3 4 5* 6* 7* 8*
PVIF (18, t) 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266
* Wrongly got printed as 4, 5, 6 and 7 respectively.

MTP Oct 21 (New) (8 Marks), MTP Oct 21 (Old) (8 Marks), May 19 (Old) (8 Marks)
Answer:
D1 = ₹6
D2 = ₹6 (1.18) = ₹7.08
D3 = ₹6 (1.18)2 = ₹8.35
D4 = ₹6 (1.18)3 = ₹9.86
D5 = ₹9.86 (1.17) = ₹11.54
D6 = ₹9.86 (1.17) (1.16) = ₹13.38
D7 = ₹9.86 (1.17) (1.16) (1.15) = ₹15.39
D8 = ₹9.86 (1.17) (1.16) (1.15) (1.14) = ₹17.54
50
D1 D2 D3 D4 D5 D6 D7 TV
P= + + + + + + +
(1+ke ) (1+ke )2 (1+k )3 (1+k )4 (1+k )5 (1+k )6 (1+k )7 (1+ke )7
e e e e e
D8 17.54
TV = = = ₹438.50
ke -g 0.18-0.14
6.00 7.08 8.35 9.86 11.54 13.38 15.39 438.50
P= + + + + + + +
ሺ1+0.18ሻ ሺ1+0.18ሻ ሺ1+0.18ሻ ሺ1+0.18ሻ ሺ1+0.18ሻ ሺ1+0.18ሻ ሺ1+0.18ሻ (1+0.18)7
2 3 4 5 6 7
= 6.00 × 0.847 + 7.08 × 0.718 + 8.35 × 0.609 + 9.86 × 0.516 + 11.54 × 0.437 + 13.38 ×
0.370 + 15.39 × 0.314 + 438.50 × 0.314
= ₹172.85
Since the Intrinsic Value of share is ₹172.85 while it is selling at ₹150 hence it is
underpriced and better to acquire it.
Question 33
An investor is considering to purchase the equity shares of LX Ltd., whose current market price
(CMP) is ₹112. The company is proposing a dividend of ₹4 for the next year. LX Ltd. is expected
to grow @ 20 per cent per annum for the next four years. The growth will decline linearly to 16
per cent per annum after first four years. Thereafter, it will stabilise at 16 per cent per annum
infinitely. The investor requires a return of 20 per cent per annum.
You are required:
(i) To calculate the intrinsic value of the share of LX Ltd.
(ii) Whether it is worth to purchase the share at this price.
Period 1 2 3 4 5 6 7
PVIF (20%, n) 0.833 0.694 0.579 0.482 0.402 0.335 0.279

Answer:
D1 = ₹4
D2 = ₹4 (1.20) = ₹4.80
D3 = ₹4 (1.20)2 = ₹5.76
D4 = ₹4 (1.20)3 = ₹6.91
D5 = ₹6.91 (1.19) = ₹8.22
D6 = ₹6.91 (1.19) (1.18) = ₹9.70
D7 = ₹6.91 (1.19) (1.18) (1.17) = ₹11.35
D8 = ₹6.91 (1.19) (1.18) (1.17) (1.16) = ₹13.17
51
D1 D2 D3 D4 D5 D6 D7 TV
P= + + + + + + +
(1+ke ) (1+ke )2 (1+ke )3 (1+ke )4 (1+ke )5 (1+ke )6 (1+ke )7 (1+ke )7
D8 13.17
TV = = = ₹329.25
ke -g 0.20-0.14
4.00 4.80 5.76 6.91 8.22 9.70 11.35 329.25
P= + + + + + + +
(1+0.20) (1+0.20) (1+0.20) (1+0.20) (1+0.20) (1+0.20) (1+0.20) 1+0.20)7
2 3 4 5 6 7
= 4.00 × 0.833 + 4.80 × 0.694 + 5.76 × 0.579 + 6.91 × 0.482 + 8.22 ×

0.402 + 9.70 × 0.335 + 11.35 × 0.279 + 329.25 × 0.279
(i) Intrinsic Value = ₹114.91

(ii) As Intrinsic Value of the share is higher than its selling price of ₹112, it is underpriced
and can be acquired. However, other factors need to be taken into consideration
since difference is only slightly higher.
Question 34
The current EPS of M/s VEE Ltd. is ₹4. The company has shown an extraordinary growth of
40% in its earnings in the last few year. This high growth rate is likely to continue for the next 5
years after which growth rate in earnings will decline from 40% to 10% during the next 5 years
and remain stable at 10% thereafter. The decline in the growth rate during the five year transition
period will be equal and linear. Currently, the company's pay-out ratio is 10%. It is likely to remain
the same for the next five years and from the beginning of the sixth year till the end of the 10th
year, the pay-out will linearly increase and stabilize at 50% at the end of the 10th year. The post
tax cost of capital is 17% and the PV factors are given below:
Years 1 2 3 4 5 6 7 8 9 10
PVIF @17% 0.855 0.731 0.625 0.534 0.456 0.390 0.333 0.285 0.244 0.209
You are required to calculate the intrinsic value of the company's stock based on expected
dividend. If the current market price of the stock is ₹125, suggest if it is advisable for the investor
to invest in the company's stock or not.
Answer: Working Notes:

(i) Computation of Growth Rate in Earning and EPS
Years 1 2 3 4 5 6 7 8 9 10
Growth in Earning 40% 40% 40% 40% 40% 34% 28% 22% 16% 10%
EPS (₹) 5.60 7.84 10.98 15.37 21.51 28.82 36.89 45.00 52.20 57.42
52
(ii) Computation of Payout Ratio and Dividend

Years 1 2 3 4 5 6 7 8 9 10
Payout Ratio 10% 10% 10% 10% 10% 18% 26% 34% 42% 50%
Dividend (₹) 0.56 0.78 1.10 1.54 2.15 5.19 9.59 15.30 21.92 28.71
(iii) Calculation of PV of Dividend

Year Dividend (₹) PVF PV of Dividend (₹)
1 0.56 0.855 0.48
2 0.78 0.731 0.57
3 1.10 0.625 0.69
4 1.54 0.534 0.82
5 2.15 0.456 0.98
6 5.19 0.390 2.02
7 9.59 0.333 3.19
8 15.30 0.285 4.36
9 21.92 0.244 5.35
10 28.71 0.209 6.00
24.46
28.71(1.10)
TV = × 0.209 = ₹94.29 Intrinsic Value = ₹24.46 + ₹94.29 = ₹118.75
0.17-0.10
Since the Intrinsic Value of Equity share is less than current market price, it is not
advisable to invest in the same.
Question 35
SAM Ltd. has just paid a dividend of ₹2 per share and it is expected to grow @ 6% p.a. After
paying dividend, the Board declared to take up a project by retaining the next three annual
dividends. It is expected that this project is of same risk as the existing projects. The results of
this project will start coming from the 4th year onward from now. The dividends will then be ₹2.50
per share and will grow @ 7% p.a.
An investor has 1,000 shares in SAM Ltd. and wants a receipt of at least ₹2,000 p.a. from
this investment.
Required:
(i) EVALUATE whether the market value of the share is affected by the decision of the Board.
53
(ii) RECOMMEND how the investor can maintain his target receipt from the investment for first
3 years and improved income thereafter, given that the cost of capital of the firm is 8%.
May 16 (8 Marks), RTP May 18 (New), RTP May 18 (Old), MTP March 22 (6 Marks), MTP Mar 18 (New) (7
Marks), MTP Oct 20 (New) (8 Marks), Practice Manual
Answer:
(i)
Dg 2(1.06)
Value of share at present = = = ₹106
ke -g 0.08-0.06
However, if the Board implement its decision, no dividend would be payable for 3 years
and the dividend for year 4 would be ₹2.50 and growing at 7% p.a. The price of the share,
in this case, now would be:
2.50 1
P0 = × = ₹198.46
0.08-0.07 (1+0.08)3
So, the price of the share is expected to increase from ₹106 to ₹198.45 after the
announcement of the project. The investor can take up this situation as follows:
Expected market price after 3 years 2.50 ₹250.00
=
0.08-0.07
Expected market price after 2 years 2.50 1 ₹231.48
= ×
0.08-0.07 (1+0.08)
Expected market price after 1 years 2.50 1 ₹214.33
= × 2
0.08-0.07 (1+0.08)
(ii) In order to maintain his receipt at ₹2,000 for first 3 year, he would sell
10 shares in first year @ ₹ 214.33 for ₹2,143.30
9 shares in second year @ ₹ 231.48 for ₹2,083.32
8 shares in third year @ ₹ 250 for ₹2,000.00
At the end of 3rd year, he would be having 973 shares valued @ ₹250 each i.e. ₹2,43,250.
On these 973 shares, his dividend income for year 4 would be @ ₹2.50 i.e. ₹2,432.50.
Thus, if the project is taken up by the company, the investor would be able to maintain his
receipt of at least ₹2,000 for first three years and would be getting increased income
thereafter.
54
Question 36
Mr. A is thinking of buying shares at ₹500 each having face value of ₹100. He is expecting a
bonus at the ratio of 1:5 during the fourth year. Annual expected dividend is 20% and the same
rate is expected to be maintained on the expanded capital base. He intends to sell the shares
at the end of seventh year at an expected price of ₹900 each. Incidental expenses for purchase
and sale of shares are estimated to be 5% of the market price. He expects a minimum return of
12% per annum.
Should Mr. A buy the share? If so, what maximum price should he pay for each share? Assume
no tax on dividend income and capital gain.
MTP Apr 19 (New) (6 Marks), Practice Manual
Answer:
P.V. of dividend stream and sales proceeds
Year Dividend/Sale PVF (12%) PV (₹)
1 ₹20/- 0.893 17.86
2 ₹20/- 0.797 15.94
3 ₹20/- 0.712 14.24
4 ₹24/- 0.636 15.26
5 ₹24/- 0.567 13.61
6 ₹24/- 0.507 12.17
7 ₹24/- 0.452 10.85
7 ₹1026/- (₹900 × 1.2 × 0.95) 0.452 463.75
₹563.68
Less: Cost of Share (₹500 × 1.05) ₹525.00
Net gain ₹38.68
Since Mr. A is gaining ₹38.68 per share, he should buy the share.
Maximum price Mr. A should be ready to pay is ₹563.68 which will include incidental
expenses. So, the maximum price should be ₹563.68 × 100/105 = ₹536.84
55
Question 37
You are interested in buying some equity stocks of RK Ltd. The company has 3 divisions
operating in different industries. Division A captures 10% of its industries sales which is
forecasted to be ₹50 crore for the industry. Division B and C captures 30% and 2% of their
respective industry's sales, which are expected to be 20 crore and ₹8.5 crore respectively.
Division A traditionally had a 5% net income margin, whereas divisions B and C had 8% and
10% net income margin respectively. RK Ltd. has 3,00,000 shares of equity stock outstanding,
which sell at ₹250.
The company has not paid dividend since it started its business 10 years ago. However from
the market sources you come to know that RK Ltd. will start paying dividend in 3 years’ time and
the pay-out ratio is 30%. Expecting this dividend, you would like to hold the stock for 5 year. By
analysing the past financial statements, you have determined that RK Ltd.'s required rate of
return is 18% and that P/E ratio of 10 for the next year and on ending P/E ratio of 20 at the end
of the fifth year are appropriate.
Required:
(i) Would you purchase RK Ltd. equity at this time based on your one year forecast?
(ii) If you expect earnings to grow @ 15% continuously, how much are you willing to pay for
the stock of RK Ltd?
Ignore taxation.
PV factors are given below:
Years 1 2 3 4 5
PVIF @ 18% 0.847 0.718 0.609 0.516 0.437
Nov 19 (Old) (8 Marks), MTP March 21 (New) (8 Marks)

Answer:
Working Notes:
Computation of Earnings Per Share (EPS)
Particulars Amount (₹)
Margin of Division A (₹50 crore × 10% × 5%) 25,00,000
Margin of Division B (₹20 crore × 30% × 8%) 48,00,000
Margin of Division C (₹8.5 crore × 2% × 10%) 1,70,000
74,70,000
No. of Equity Shares 3,00,000
EPS ₹24.90
56
(i) Market Price based on One Year Forecast

Expected Market Price at the end of the year = ₹24.90 × 10 = ₹249
PV of the Expected Price = ₹249 × 0.847 = ₹210.90

I would NOT like to purchase the share as the expected market price of shares is less
than its current price of ₹250.
(ii) If Earning is expected to grow @ 15%

Year EPS (₹) Dividend (₹) PVF @ 18% PV (₹)
1 28.64 --- 0.847 ---
2 32.93 --- 0.718 ---
3 37.87 11.36 0.609 6.92
4 45.55 13.07 0.516 6.74
5 50.08 15.02 0.437 6.56
20.22
15.02(1.15)
Share Price after 5 years = = ₹575.77
0.18-0.15
PV of the Market Price after 5 years = ₹575.77 × 0.437 = ₹251.61

Total PV of Inflows = ₹20.22 + ₹251.61 = ₹271.83
Thus, the maximum price I would be willing to pay for the share shall be ₹271.83.
Question 38
Lockheed Martin (LM) the aerospace and defense conglomerate, has a stellar dividend history,
with steadily increasing quarterly payments since 1995. In recent years, however, the rate of
dividend growth has declined from a solid 15.6% in 2014 to 10% in 2016. Of course, the 2016
fiscal year has just begun as of this writing, but the total dividend can be extrapolated from the
first quarter dividend of $1.65 per share and the company’s history of consistent quarterly
payments.
Based on this steady rate of decline, it can be assumed that dividend growth will again decrease
by 2.8% in 2017 and then stabilize at a healthy 7.2% thereafter. This example will use LMT’s
actual dividend performance for 2013 through 2016, along with a projected decline and
stabilization in 2017, to produce a value estimate for the stock in 2013 using the H model
dividend discount calculation. For the purposes of this example, a 10% expected rate of return
is used. The number of years over which the growth rate will transition is four. Calculate the
value estimate using the 2013 dividend payment of $4.60.
57
Answer:
Value of stock using H Model
D0 (1+gn ) D0 × H × (gc -gn )
MP = +
Ke -gn Ke -gn
4.6ሺ1.072ሻ 4.60 × 2 × ሺ0.1560 - 0.072ሻ

= +
0.10-0.072 0.10 - 0.072
= 176.11 + 27.60
= $203.71
Question 39
Piyush Loonker and Associates presently pay a dividend of Re. 1.00 per share and has a share
price of ₹20.00.
a. CALCULATE the firm’s expected or required return on equity using a dividend- discount
model approach if this dividend were expected to grow at a rate of 12% per annum
forever.
b. CALCULATE the firm’s expected, or required, return on equity if instead of this situation
in part (i), suppose that the dividends were expected to grow at a rate of 20% per annum
for 5 years and 10% per year thereafter.
RTP Nov 18 (New), Practice Manual, StudyMat
Answer:
(i) Firm’s Expected or Required Return on Equity
According to Dividend discount model approach the firm’s expected or required return
on equity is computed as follows:
D1
Ke = +g
P0
Where,
Ke = Cost of equity share capital or (Firm’s expected or required return on equity share
capital)
D1 = Expected dividend at the end of year 1
P0 = Current market price of the share.
g = Expected growth rate of dividend.
Now, D1 = D0 (1 + g) or ₹1 (1 + 0.12) or ₹1.12, P0 = ₹20 and g = 12% per annum
₹1.12
Therefore,Ke = +12%
₹20
Or, Ke = ₹17.6%
58
(ii) Firm’s Expected or Required Return on Equity

(If dividends were expected to grow at a rate of 20% per annum for 5 years and 10% per
year thereafter)
Since in this situation if dividends are expected to grow at a super normal growth rate
gs, for n years and thereafter, at a normal, perpetual growth rate of g n beginning in the
year n + 1, then the cost of equity can be determined by using the following formula:
n t
Div0 (1+gs ) Divn+1 1
P0 = ∑ t
+ × n
(1+Ke ) Ke -gn (1+Ke )
t=1
Where,
gs = Rate of growth in earlier years.
gn = Rate of constant growth in later years.
P0 = Discounted value of dividend stream.
Ke = Firm’s expected, required return on equity (cost of equity capital).
Now,
gs = 20% for 5 years, gn = 10%
Therefore,
n t
D0 (1+0.20) Div5+1 1
P0 = ∑ + ×
(1+Ke )
t Ke -0.10 (1+Ke )n
t=1
1.20 1.44 1.73 2.07 2.49 2.49(1+0.10) 1

0= 1
+ 2
+ 3
+ 4
+ 5
+ × 5
(1+Ke ) (1+ Ke ) (1+ Ke ) (1+ Ke ) (1+ Ke ) -0.10 (1+ Ke )
Or
P0 = ₹1.20 (PVF1, Ke) + ₹1.44 (PVF2, Ke) + ₹1.73 (PVF3, Ke) + ₹2.07
₹2.74(PVF5 ,Ke )
ሺPVF4 ,Ke ሻ+₹2.49ሺPVF5 ,Ke ሻ+
Ke -0.10
By trial and error, we are required to find out Ke

Now, assume Ke = 18% then we will have
P0 = ₹1.20ሺ0.8475ሻ+₹1.44ሺ0.7182ሻ+₹1.73ሺ0.6086ሻ+₹2.07ሺ0.5158ሻ
1
+₹2.49ሺ0.4371ሻ+₹2.74(0.4371) ×
0.18-0.10
= ₹1.017 + ₹1.034 + ₹1.053 + ₹1.068 + ₹1.09 + ₹14.97
= ₹20.23
59
Since the present value of dividend stream is more than required it indicates that Ke
is greater than 18%.
Now, assume Ke = 19% we will have
P0 = ₹1.20ሺ0.8403ሻ+₹1.44ሺ0.7061ሻ+₹1.73ሺ0.5934ሻ+₹2.07ሺ0.4986ሻ
1
+₹2.49ሺ0.4190ሻ+₹2.74(0.4190) ×
0.19-0.10
= ₹1.008 + ₹1.017 + ₹1.026+ ₹1.032 + ₹1.043 + ₹12.76
= ₹17.89
Since the market price of share (expected value of dividend stream) is ₹20. Therefore,
the discount rate is closer to 18% than it is to 19%, we can get the exact rate by
interpolation by using the following formula:
NPV at LR
Ke = LR+ × ∆r
NPV at LR-NPV at HR
Where,
LR = Lower Rate
NPV at LR = Present value of share at LR
NPV at HR = Present value of share at Higher Rate
∆r = Difference in rates
ሺ₹20.23-₹20ሻ ₹0.23
K = 18%+ × 1% = 18%+ × 1% = 18% + 0.10% = 18.10%
₹20.23-₹17.89 ₹2.34
Therefore, the firm’s expected, or required, return on equity is 18.10%. At this rate the
present discounted value of dividend stream is equal to the market price of the share.
Question 40
Consider the data given below and calculate the FCFE and FCFF.
Balance Sheet
Assets 2016 2015
Cash 30 15
Accounts Receivables 90 45
Inventory 120 90
Current Assets 240 150
Gross PPE 1200 900
Accumulated Depreciation 570 420
Total Assets 870 630
60
Liabilities 2016 2015

Accounts Payable 60 60
Short Term Debt 60 30
Current Liabilities 120 90
Long term Debt 342 300
Common Stock 150 150
Retained Earnings 258 90
Total Liabilities and Equities 870 630
Income Statement
2016 2015
Sales 900 750
COGS 360 300
Gross Profit 540 450
Selling and Admin. Exp. 105 90
EBITDA 435 360
Depreciation 150 120
EBIT 285 240
Interest Expense 45 30
EBT 240 210
Tax (30%) 72 63
Net Income 168 147
Answer:
a) FCFE
FCFE = PAT + Depreciation – ΔCAPEX – ΔWC – Repayment of Debt + New debt
issued
= 168 + 150 – 300 – 75 – 0 + 72
= ₹15 Lakhs
61
1. CAPEX = 300
Fixed Assets
Opening 900
CAPEX 300
Closing 1200
1200 1200
Accumulated Depreciation
Opening 420
P&L 150
Closing 570
570 570
2. ΔWC
Non Cash WC (2016) = Non Cash CA – Non Cash CL
= (240 – 30) – (120 – 60)
= 210 – 60 = 150
Non Cash WC (2015) = (150 – 15) – (90 – 30)
= 135 – 60
= 75
ΔWC = 150 – 75 = 75
3. New Fund Issued

Short Term Debt 60 – 30 = 30
Long Term Debt 342 – 300 = 42
New Debt = 72
a) FCFF
FCFF = EBIT (1 – tax) + Depreciation – ΔCAPEX – ΔWC
= 285 (1 – 0.30) + 150 – 300 – 75 + 30
= 199.50 + 150 – 300 – 75 + 30
= -25.50 + 30
= 4.50
62
Question 41
Calculate the value of share from the following information:
Profit after tax of the company ₹290 crores
Equity capital of company ₹1,300 crores
Par value of share ₹40 each
Debt ratio of company (Debt/ Debt + Equity) 27%
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share ₹47
Depreciation per share ₹39
Change in Working capital ₹3.45 per share
June 09 (6 Marks), MTP Feb 15 (6 Marks), MTP Oct 15 (5 Marks), MTP April 19 (Old) (5 Marks), MTP Aug 18 (4
Marks), RTP Nov 13, RTP Nov 14, RTP May 20 (New), RTP Nov 19 (Old), StudyMat
Answer:
No. of Shares = (₹1300 crores)/(₹40) = 32.5 crores
PAT ₹290 crores
EPS = = = ₹8.923
No. of Shares 32.5 crores
FCFE = Net income – [(1-b) (capex – dep) + (1-b) (ΔWC)]

= 8.923 – [(1-0.27) (47-39) + (1-0.27) (3.45)]
= 8.923 – [5.84 + 2.5185]
= 0.5645
Cost of Equity = Rf + ß (Rm – Rf) = 8.7 + 0.1 (10.3 – 8.7) = 8.86%
FCFEሺ1+gሻ 0.5645ሺ1.08ሻ 0.60966

Po = = = = ₹70.89
Ke -g 0.0886-0.08 0.0086
Question 42
Consider the following:
Risk free rate 5%
β 1.5
and, Market risk premium 4.5%
Calculate Required return on equity. StudyMat

63
Answer:
Required return on share A = Risk free return + β × Market Risk Premium
= 0.05 + 1.5 (0.045)
= 0.1175 or 11.75%
Question 43
The balance sheet of Hkurp Ltd is as follows
Non-Current Assets 1000
Current Asset
Trade Receivables 500
Cash and Cash Equivalents 500
2000
Shareholders’ Funds 800

Long Term Debt 200
Current Liabilities and Provisions 1000
2000
The shares are actively traded and the current market price is 12 per share. Shareholders’ funds
represent 70 shares of 10 each and rest is retained earnings. You are required to find out the
Enterprise Value. StudyMat
Answer:
Enterprise Value = Market Value of Equity + Market Value of Debt – Cash & Cash
Equivalents
= (70 × 12) + 200 – 500
= 540 Lakhs
Note: Since no information on Market Value of Debt has been given separately.
The book value has been assumed as the market Value.
Question 44
An analyst has determined that the appropriate EV/EBITDA for Rainbow Company is 10.2. The
analyst has also collected the following forecasted information for Rainbow Company:
EBITDA = $22,000,000
Market value of debt = $56,000,000
Cash = $1,500,000
Calculate the value of equity for Rainbow Company?
64
Answer:
Enterprise Value
EV Multiple =
EBITDA
Enterprise Value
10.20 =
22,000,000
Enterprise Value = 224,400,000

Enterprise Value = Market Value of Equity + Market Value of Debt – Cash & Cash Equivalents
224400000 = Equity Value + 56000000 – 1500000
Equity Value = $169,900,000
Question 45
Jorge Zaldys, CFA, is researching the relative valuation of two companies in the
aerospace/defense industry, NCI Heavy Industries (NCI) and Relay Group International (RGI).
He has gathered relevant information on the companies in the following table
Company RGI NCI
Price per share 150 100
Shares Outstanding 5 Million 2 Million
Market Value of the debt 50 100
Book Value of debt 52 112
Cash and Investment 5 2
Net Income 49.5 12
Net Income from continuing operations 49.5 8
Interest Expense 3 5
Depreciation and Amortization 8 4
Taxes 2 3
Using the information in the table, answer the following questions:

a. Calculate P/EBITDA for NCI and RGI.
b. Calculate EV/EBITDA for NCI and RGI.
c. Which company should Zaldys recommend as relatively undervalued? Justify the selection
Answer:
Enterprise Value = Market Value of Equity + Market Value of Debt – Cash & Cash
Equivalents
EVNCI = 100 × 2 + 100 – 2 = 298
EVRGI = 150 × 5 + 50 – 5 = 795
65
EBITDA = Net Income from continuing operations + Tax + Interest + D & A

EBITDANCI = 8 + 3 + 5 + 4 = 20
EBITDARGI = 49.50 + 2 + 3 + 8 = 62.50
RGI NCI
a) Price / EBITDA per share 150 100
(It means it costs 12 & 10 respectively for ₹1 income) = =
62.50 20
5 2
150 100
= =
12.50 10
= 12 = 10
b) EV/EBITDA
(it means it costs 12.72 & 14.90 respectively for ₹1 income) 795 298
= =
62.50 20
= 12.72 = 14.90
a) Whether the multiple is P/EBITDA or EV/EBITDA, a low multiple is always preferred over
high multiple.
According to P/EBITDA, NCI is recommended
But According to EV/EBITDA, RGI is recommended
When there is a conflict in decision due to different multiple, EV/EBITDA multiple should
be preferred as it gives proper picture of fair value of company, whereas P/EBITDA ignores
Debt & Cash balance with company.
∴RGI is undervalued & Recommended for investment purpose.
Question 46
AMKO Limited has issued 75,000 equity shares of ₹10 each. The current market price per share
is ₹36. The company has a plan to make a rights issue of one new equity share at a price of ₹24
for every four shares held.
(i) Calculate the theoretical post-rights price per share.
(ii) Calculate the theoretical value of the right alone.
Answer:
(i) Calculation of theoretical Post-rights (ex-right) price per share:
Ex-right value
MN+SR ₹36 × 4+₹24 × 1
= ൤ ൨ = ൤ ൨ = ₹33.60
N+R 4+1
Where,
66
M = Market price,
N = Number of old shares for a right share
S = Subscription price
R = Right share offer
(ii) Calculation of theoretical value of the rights alone:

= Ex-right price – Cost of rights share
= ₹33.60 – ₹24 = ₹9.60 or (₹33.60-₹24)/4 = ₹2.4
Question 47
A company offers to its shareholders the right to buy 2 shares at ₹130 each for every 5 shares
of ₹100 each held in the company. The market value of the shares is ₹200 each. Calculate the
value of right.
Answer:
Value of right = P0 – P1 = 200 – 180 = 20
nP0 +n1 s 5 × 200+2 × 130

P1 = = = 180
n+n1 5+2
Alternatively,
n1 2
V= (P0 -S) = ሺ200-130ሻ = 20
n+n1 7
Question 48
Aggressive Ltd., is proposing to fund its expansion plan of ₹12 crore by making a rights issue.
The current market price (CMP) is ₹40. The Board is willing to offer a discount of 20% on the
CMP for the rights issue. The Board is also desirous that the fall in Ex – right price of the shares
be restricted to 10% of CMP.
You are required to calculate:
(i) The number of new equity shares to be offered for each rights held,
(ii) Theoretical value of right and
(iii) The total number of equity shares to be issued.
Answer:
(i) Number of new equity shares to be offered for each rights head
Subscription Price
= ₹40 × 0.80
= ₹32 per share
67
Ex Right Price to be restricted to

= ₹40 × 0.90
= ₹36
Let R be the ratio in which right share to be issued then

₹40 + ₹32 × R
₹36=
1+R
36 + 36R = ₹40 + 32R
R=1
Thus, 1 equity share be offered for each share held.
(ii) Theoretical Value of right = ₹36 – ₹ 32 = ₹4

(iii)
₹12 Crore
No. of equity share to be issued= = 37,50,000 or 0.375 shares
₹32
Question 49
AB Limited’s shares are currently selling at ₹130 per share. There are 10,00,000 shares
outstanding. The firm is planning to raise ₹2 crores to Finance new project.
Required
What is the ex-right price of shares and value of a right, if:
(i) The firm offers one right share for every two shares held.
(ii) The firm offers one right share for every four shares held. RTP May 12
Answer:
Offer I Offer II
Amount to be raised (A) ₹200,00,000 ₹200,00,000
Offer Ratio 1:2 1:4
Existing shares 10,00,000 10,00,000
New Shares (B) 10,00,000/2 and 10,00,000/4 5,00,000 2,50,000
Right Price (A ÷ B) [OP] ₹40 ₹80
Existing value @ selling price i.e. ₹130 ₹260 ₹520
Total wealth ₹300 ₹600
No. of Shares (Total) 3 5
Ex-right Price 100 120
Value of Right (MPER – OP) ÷ No. ₹30 ₹10
68
Question 50
ABC Limited’s shares are currently selling at ₹13 per share. There are 10,00,000 shares
outstanding. The firm is planning to raise ₹20 lakhs to Finance a new project.
(i) Calculate the ex-right price of shares and the value of a right, if the firm offers one right
share for every two shares held.
(ii) Calculate the ex-right price of shares and the value of a right, if the firm offers one right
share for every four shares held.
(iii) Analyse how does the shareholders’ wealth change from (i) to (ii) above and right issue
increases shareholders’ wealth?
RTP May 14, RTP Nov 18 (New), Practice Manual, StudyMat
Answer:
(i) Number of shares to be issued: 5,00,000
Subscription price ₹20,00,000 / 5,00,000 = ₹4
₹1,30,00,000+₹20,00,000
Ex-right Price = = ₹10
15,00,000
₹10-₹4
Value of right = = ₹3
2
Or = ₹10 - ₹4 = ₹6
(ii) Subscription price ₹20,00,000 / 2,50,000 = ₹8

₹1,30,00,000+₹20,00,000
Ex-right Price = = ₹12
12,50,000
₹12-₹8
Value of right = = ₹1
4
Or = ₹12 - ₹8 = ₹4
(iii) The effect of right issue on wealth of Shareholder’s wealth who is holding, say 100
shares.
a. When firm offers one share for two shares held.
Value of Shares after right issue (150 × ₹10) ₹1,500
Less: Amount paid to acquire right shares (50 × ₹ 4) ₹200
₹1,300
b. When firm offers one share for every four shares held
Value of Shares after right issue (125 × ₹12) ₹1,500
Less: Amount paid to acquire right shares (25 × ₹8) ₹200
₹1,300
69
c. Wealth of Shareholders before Right Issue ₹1,300

Thus, there will be no change in the wealth of shareholders from (i) and (ii).
Question 51
KLM Limited has issued 90,000 equity shares of ₹10 each. KLM Limited’s shares are currently
selling at ₹72. The company has a plan to make a rights issue of one new equity share at a
price of ₹48 for every four shares held.
(a) Calculate the theoretical post-rights price per share and analyse the change
(b) Calculate the theoretical value of the right alone.
(c) Suppose Mr. A who is holding 100 shares in KLM Ltd. is not interested in subscribing to
the right issue, then advice what should he do.
RTP May 21 (New), RTP May 21 (Old)
Answer:
(a) Calculation of theoretical Post-rights (ex-right) price per share
M N+S R
Ex-right value = ൤ ൨
N+R
Where,
M = Market Price,
₹72 × 4+₹48 × 1
=൤ ൨ = ₹67.20
4+1
Thus, post right issue the price of share has reduced by ₹4.80 per share.
(b) Calculation of theoretical value of the rights alone:

= ₹67.20 – ₹48 = ₹19.20
Or
₹67.20-₹48
= = ₹4.80
4
(c) If Mr. A is not interested in subscribing to the right issue, he can renounce his right
eligibility @ ₹19.20 per right and can earn a gain of ₹480.
70
Question 52
Pragya Limited has issued 75,000 equity shares of ₹10 each. The current market price per share
is ₹24. The company has a plan to make a rights issue of one new equity share at a price of ₹16
for every four share held.
(i) Calculate the theoretical post-rights price per share;
(ii) Calculate the theoretical value of the right alone;
(iii) Show the effect of the rights issue on the wealth of a shareholder, who has 1,000 shares
assuming he sells the entire rights; and
(iv) Show the effect, if the same shareholder does not take any action and ignores the issue.
RTP May 13, RTP Nov 14, RTP Nov 18 (Old), MTP April 14 (5 Marks), Practice Manual
Answer:
(i) Calculation of theoretical Post-rights (ex-right) price per share:
MN+SR
Ex-right value = ൤ ൨
N+R
Where,
M = Market price,
ሺ₹24 × 4ሻ+ሺ₹16 × 1ሻ
= ቈ ቉ = ₹22.40
4+1
(ii) Calculation of theoretical value of the rights alone:
= ₹22.40 – ₹16 = ₹6.40
Or
₹22.40-₹16
= = ₹1.60
4
(iii) Calculation of effect of the rights issue on the wealth of a shareholder who has
1,000 shares assuming he sells the entire rights:
₹
(a) Value of shares before right issue 24,000
(1,000 shares × ₹24)
(b) Value of shares after right issue 22,400
(1,000 shares × ₹22.40)
71
Add: Sale proceeds of rights renunciation 1,600

(250 shares × ₹6.40)
24,000
There is no change in the wealth of the shareholder even if he sells his right.
(iv) Calculation of effect if the shareholder does not take any action and ignores the
issue:
₹
Value of shares before right issue (1,000 shares × ₹24) 24,000
Less: Value of shares after right issue (1,000 shares × ₹22.40) 22,400
Loss of wealth to shareholders, if rights ignored 1,600
Question 53
The stock of the Soni plc is selling for £50 per common stock. The company then issues rights
to subscribe to one new share at £40 for each five rights held.
a) What is the theoretical value of a right when the stock is selling rights-on?
b) What is the theoretical value of one share of stock when it goes ex-rights?
c) What is the theoretical value of a right when the stock sells ex-rights at £50?
d) John Speculator has £1,000 at the time Soni plc goes ex-rights at £50 per common stock.
He feels that the price of the stock will rise to £60 by the time the rights expire. Compute his
return on his £1,000 if he (1) buys Soni plc stock at £50, or (2) buys the rights at the price
computed in part c, assuming his price expectations are valid.
Practice Manual
Answer:
a) Value of Right = P0 – P1 = 50 – 48.33 = £1.67
b)
nP0 +n1 s 250+40
Ex Right Price (P1 ) = = = £48.33
n+n1 5+1
c)
P0 -S 50-40
V= = = £2
N 5
d)
£1000
Buy Stock @£50 = = 20 Stock
50
Sell Stock @£60 × 20 = £1200 Stock
72
Profit (1200 – 1000) = £200

£1000
No. of rights purchased = = 500 Rights
2
When the stock is £50 one could purchase the same at £40 if he has rights, the value
of which is £2. This will give the benefit of £10 pounds in the price of the stock. But
when the price of the share goes to £60. The rights becomes more attractive because
one can still purchase the share under right at £40 which is worth £60 and save £20;
this will result into higher demand of rights and accordingly the value of rights will
increase.
P0 -S 60-40 20
V= = = =4
N 5 5
John will sell rights purchased at £2 for £4 when the share price goes 60. Hence he
makes profit of £2 on each right. Thus total profit = 500 × 2 = £1000
Question 54
Telbel Ltd. is considering undertaking a major expansion an immediate cash outlay of ₹150
crore. The Board of Director of company are expecting to generate an additional profit of
₹15.30 crore after a period of one year. Further, it is expected that this additional profit shall
grow at the rate of 4% for indefinite period in future.
Presently, Telbel Ltd. is completely equity financed and has 50 crore shares of ₹10 each. The
current market price of each share is ₹22.60 (cum dividend). The company has paid a dividend
of ₹1.40 per share in last year. For the last few years dividend is increasing at a compound
rate of 6% p.a. and it is expected to be continued in future also. This growth rate shall not be
affected by expansion project in any way.
Boards of Directors are considering following ways of financing the possible expansion:
1. A right issue on ratio of 1:5 at price of ₹15 per share.
2. A public issue of shares.
In both cases the dividend shall become payable after one year. You as a Financial Consultant
required to:
(a) Determine whether it is worthwhile to undertake the project or not.
(b) Calculate ex-dividend market price of share if complete expansion is financed from
the right issue.
(c) Calculate the number of new equity shares to be issued and at what price assuming
that new shareholders do not suffer any loss after subscribing new shares.
(d) Calculate the total benefit from expansion to existing shareholders under each of two
financing option.
RTP Nov 15
73
Answer:
Working Note:
Calculate of Cost of Capital
D0 (1+g)
ke = +g
P0
D1 = ₹1.40, P0 = ₹22.60 - ₹1.40 = ₹21.20
1.40(1+0.06)
ke = +0.06 = 13%
21.20
(a) NPV of the Project

This ke shall be used to value PV of income stream
₹15.30 crore ₹15.30 crore
V= = = ₹170 crore
ke -g 0.13-0.04
PV of Cash Inflows from Expansion Project ₹170 crore
Less: PV of Initial Outlay ₹150 crore
NPV ₹20 crore
Since NPV is positive we should accept the project.

(b) By right issue new number of equity shares to be issued shall be:
50 crore (Existing) + 10 crore (Right Issue) = 60 crore
Market Value of Company = PV of Existing earnings + PV of earnings from Expansion
₹1.40 × 50crore × (1+0.06)
= +₹170crore
0.13-0.06
= ₹1060 crore + ₹170 crore
= ₹1230 crore
Price Per Share = ₹1230 crore / 60 crore = ₹20.50
(c) Let n be the number of new equity shares to be issued then such shares are to be
issued at such price that new shareholders should not suffer any immediate loss after
subscribing shares. Accordingly,
n
× ₹1230crore = ₹150crore
50crore+n
1230 n = 7500 + 150n

n = 7500/1080 = 6.9444 crore
₹150crore
Issue Price Per Share = = ₹21.60 Or
6.9444crore
₹1230 crore
Ex-Dividend Price Per Share = = ₹21.60
56.9444 crore
74
(d) Benefits from Expansion

Right Issue
₹ crore ₹ crore
Shareholder’s Current Wealth (₹22.60 × 50 crore) 1130
Less:
Value of 60 crore shares @₹20.50 1230
Cash Dividend Received @ ₹1.40 per Share on 50 crore shares 70
Cash paid to subscribe Right Share (₹15 × 10crore) (150) 1150
Net Gain 20
Or
Shareholder’s Current Wealth (₹21.20 × 20crore) 1060
Less:
Value of 60 crore shares @ ₹20.50 1230
Cash paid to subscribe Right Shares (₹15 × 10crore) (150) 1080
Net Gain 20
Fresh Issue
₹ crore
Less:
Value of existing 50 crore shares @ ₹21.60 1080
Cash Dividend Received @ ₹1.40 per share on 50 crore shares 70 1150
Net Gain 20
Or
Value of Existing 50 crore shares @₹21.60 1080
Net Gain 20
75
Question 55
Progressive Corporation is planning to raise funds by making rights issue of equity shares to
finance its expansion. The existing ordinary share capital of the company is ₹1 crore. The par
value of its shares is ₹10 and the market price is ₹40.The alternatives under consideration before
the management for making rights issue are given below:
a) 4 new shares for 5 old shares at par.
b) 3 new shares for 5 old shares at ₹15
c) 2 new shares for 5 old shares at ₹20
d) One new share for 5 old shares at ₹25
You are required to analyse for each alternative:

(i) Theoretical market price after rights issue;
(ii) Value of rights;
(iii) Percentage increase in share capital,
(iv) Percentage increase in total funds.
Answer:
(i) Theoretical Market Price after right issue (Ex-right Price)
nP0 +n1 s
P1 =
n+n1
5 × 40+4 × 10
a) P1 = = 26.67
5+4
5 × 40+3 × 15
b) P1 = = 30.63
5+3
5 × 40+2 × 20
c) P1 = = 34.29
5+2
5 × 40+1 × 25
d) P1 = = 37.50
5+1
(ii) Value of Rights V = P0 – P1

a) V = 40 – 26.67 = 13.33
b) V = 40 – 30.63 = 9.37
c) V = 40 – 34.29 = 5.71
d) V = 40 – 37.50 = 2.50
76
(iii)
N1
% Increase in Share Capital =
N
4
a) = = 80%
5
3
b) = = 60%
5
2
c) = = 40%
5
1
d) = = 20%
5
(iv)
𝐒 N1
% increase in total Funds = ×
P0 N
10
a) × 0.80 = 20%
40
15
b) × 0.60 = 22.50%
40
20
c) × 0.40 = 20%
40
25
d) × 0.20 = 12.50%
40
Question 56
The face value of the preference share is ₹10,000 and the stated dividend rate is 10%. The
shares are redeemable after 3 years period. Calculate the value of preference shares if the
required rate of return is 12%. StudyMat
Answer:
Annual dividend = ₹10000 × 10% = ₹1000
Redeemable Preference share value
1,000 1,000 1,000+10,000
= + +
(1+0.12) (1+0.12)2 (1+0.12)
3
1,000 1,000 11,000

= + +
(1.12) (1.12)2 (1.12)3
= 892.86 + 797.19 + 7829.58
= ₹9519.63
Solving the above equation, we get the value of the preference shares as ₹9519.63
77
Question 57
There is a 9% 5-year bond issue in the market. The issue price is ₹90 and the redemption
price ₹105. For an investor with marginal income tax rate of 30% and capital gains tax rate of
10% (assuming no indexation), what is the post-tax yield to maturity?
MTP Sept 15 (5 Marks), Practice Manual
Answer:
Calculation of yield to Maturity (YTM)
Coupon + Pro-rated discount
YTM =
(Redemption price + Purchase Price)/2
After tax coupon = 9 × (1 – .30) = 6.3
After tax redemption price = 105 – (15 × .10) or ₹103.5
After tax capital gain = 103.50 – 90 = ₹13.50
6.3+(13.5/5) 9.00
YTM = or = 9.30% p. a.
(103.5+90)/2 96.75
Question 58
If the market price of the bond is ₹95; years to maturity = 6 yrs: coupon rate = 13% p.a (paid
annually) and issue price is ₹100. What is the yield to maturity?
MTP Feb 14 (5 Marks), Practice Manual
Answer:
(F-P)
C+
YTM = n
F+P
2
C = Coupon Rate, F = Face Value (Issue Price), P = Market Price of Bond
(100-95)
13+
YTM = 6 = 0.1418 or 14.18% p. a.
100+95
2
78
Question 59
Following information is available in respect of a bond
Face value ₹1000
Coupon Rate 8%
Time to Maturity 10 years
Market Price ₹1140
Callable in 6 years ₹1100
Find out the YTM and YTC of the bond?
Answer:
a)
Ru - Mp
C+
YTM = n
Ru + Mp
2
1000 -1140
80 +
= 10
1000 + 1140
2
80 - 14
=
1070
YTM = 6.17% p.a.
MP (1140) > FU (1000), YTM (6.17%) ˂ CR (8%)
b)
Ru -Mp
C+
YTC = n
Ru +Mp
2
1100-1140
80+
= 6
1100+1140
2
80-6.667
=
1120
YTC = 6.55% p.a.
79
Question 60
An investor is considering the purchase of the following Bond:
Face value ₹100
Coupon rate 11%
Maturity 3 years
i) If he wants a yield of 13% what is the maximum price, he should be ready to pay for?
ii) If the Bond is selling for ₹97.60, what would be his yield?
Nov 09 (4 Marks), MTP Aug 16 (5 Marks), Practice Manual
Answer:
i) Calculation of Maximum price
Bo = ₹11 × PVIFA (13%, 3) + ₹100 × PVIF (13%, 3)
= ₹11 × 2.361 + ₹100 × 0.693
= ₹25.97 + ₹69.30
= ₹95.27
ii) Calculation of yield

At 12% the value = ₹11 × PVIFA (12%, 3) + 100 × PVIF (12%, 3)
= ₹11 × 2.402 + ₹100 × 0.712
= ₹26.42 + ₹71.20
= ₹97.62
Since bond is selling at ₹97.60, the YTM of the bond shall be approximately 12%.
Question 61
Nominal value of 10% Bonds issued at par by M/s SK Ltd. is ₹100. The bonds are redeemable
at ₹110 at the end of year 5.
I. Determine the value of the bond if required yield is:
(i) 8%
(ii) 9%
(iii) 10%
(iv) 11%
II. When will the value of the bond be highest?
Given below are Present Value Factors:
Year 1 2 3 4 5
PV Factor @ 8% 0.926 0.857 0.794 0.735 0.681
PV Factor @ 9% 0.917 0.842 0.772 0.708 0.650
80
PV Factor @ 10% 0.909 0.826 0.751 0.683 0.621

PV Factor @ 11% 0.901 0.812 0.731 0.659 0.593
Nov 19 (Old) (5 Marks), RTP Nov 13, MTP Feb 14, Practice Manual
Answer:
Case (i) Required yield rate = 8%
Year Cash Flow ₹ DF (8%) Present Value ₹
1-5 10 3.993 39.93
5 110 0.681 74.91
Value of bond 114.84
Case (ii) Required yield rate = 9%

1-5 10 3.889 38.89
5 110 0.650 71.50
Case (iii) Required yield rate = 10%
1-5 10 3.790 37.90
5 110 0.621 68.31
Case (iv) Required yield rate = 11%

1-5 10 3.696 36.96

5 110 0.593 65.23
Decision -The value shall be highest when required yield is 8%.
81
Question 62
Nominal value of 10% bonds issued by a company is ₹100. The bonds are redeemable at ₹110
at the end of year 5.
Determine the value of the bond if required yield is (i) 5%, (ii) 5.1%, (iii) 10% and (iv) 10.1%.
MTP Feb 14 (8 Marks), RTP Nov 13, StydyMat
Answer:
Case (i) Required yield rate = 5%
1-5 10 4.3295 43.295
5 110 0.7835 86.185
Case (ii) Required yield rate = 5.1%

Year Cash Flow ₹ DF (5.1%) Present Value ₹
1-5 10 4.3175 43.175
5 110 0.7798 85.778
Case (iii) Required yield rate = 10%
1-5 10 3.7908 37.908
5 110 0.6209 68.299
Case (iv) Required yield rate = 10.1%

Year Cash Flow ₹ DF (10.1%) Present Value ₹
1-5 10 3.7811 37.811
5 110 0.6181 67.991
82
Question 63
On 31st March, 2013, the following information about Bonds is available:
Name of Security Face Maturity Date Coupon Coupon Date(s)
Value ₹ Rate
Zero coupon 10,000 31st March, 2023 N.A. N.A.
T-Bill 1,00,000 20th June, 2013 N.A. N.A.
10.71% GOI 2023 100 31st March, 2023 10.71 31st March
10 % GOI 2018 100 31st March, 2018 10.00 31st March & 31st October
Calculate:
st
(i) If 10 years yield is 7.5% p.a. what price the Zero Coupon Bond would fetch on 31 March,
2013?
(ii) What will be the annualized yield if the T-Bill is traded @ 98500?
(iii) If 10.71% GOI 2023 Bond having yield to maturity is 8%, what price would it fetch on April
1, 2013 (after coupon payment on 31st March)?
(iv) If 10% GOI 2018 Bond having yield to maturity is 8%, what price would it fetch on April 1,
2013 (after coupon payment on 31st March)?
May 15 (8 Marks), MTP Aug 17 (8 Marks), Practice Manual
Answer:
(i) Rate used for discounting shall be yield.
Accordingly, ZCB shall fetch:
10000
= = ₹4,852
ሺ1+0.075ሻ10
(ii) The day count basis is actual number days / 365.

Accordingly, annualized yield shall be:
FV-Price 365
Yield = ×
Price No. of days
100000-98500 365
= ×
98500 81
= 6.86 %
Note: Alternatively, it can also computed on 360 days a year.
83
(iii) Price GOI 2023 would fetch
= ₹10.71 PVAF (8%, 10) + ₹100 PVF (8%, 10)

= ₹10.71 × 6.71 + ₹100 × 0.4632
= ₹71.86 + ₹46.32
= ₹118.18
(iv) Price GOI 2018 Bond would fetch:

= ₹5 PVAF (4%, 10) + ₹100 PVF (4%, 10)
= ₹5 × 8.11 + ₹100 × 0.6756
= 40.55 + 67.56
= ₹108.11
Question 64
Calculate Market Price of:
(i) 10% Government of India security currently quoted at ₹110, but yield is expected to go up
by 1%.
(ii) A bond with 7.5% coupon interest, Face Value ₹10,000 & term to maturity of 2 years,
presently yielding 6%. Interest payable half yearly.
Nov 2010 (5 Marks), Practice Manual
Answer:
(i) Current yield = (Coupon Interest / Market Price) × 100
(10/110) × 100 = 9.09%
If current yield go up by 1% i.e. 10.09 the market price would be
10.09 = 10 / Market Price × 100
Market Price = ₹99.11
(ii) Market Price of Bond = P.V. of Interest + P.V. of Principal

= ₹1,394 + ₹8,885
= ₹10,279
Question 65
Based on the credit rating of bonds, Mr. Z has decided to apply the following discount rates for
valuing bonds:
Credit Rating Discount Rate
AAA 364-day T bill rate + 3% spread
AA AAA + 2% spread
A AAA + 3% spread
84
He is considering to invest in AA rated, ₹1,000 face value bond currently selling at ₹1,025.86.
The bond has five years to maturity and the coupon rate on the bond is 15% p.a. payable
annually. The next interest payment is due one year from today and the bond is redeemable at
par. (Assume the 364-day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z. Should he invest in the
bond? Also calculate the current yield and the Yield to Maturity (YTM) of the bond.
Nov 11 (8 Marks), RTP May 19 (New), Practice Manual
Answer:
The appropriate discount rate for valuing the bond for Mr. Z is:
R = 9% + 3% + 2% = 14%
Time CF PVIF 14% PV (CF) PV (CF)
1 150 0.877 131.55
2 150 0.769 115.35
3 150 0.675 101.25
4 150 0.592 88.80
5 1150 0.519 596.85
Σ PV (CF) i.e. P0 = 1033.80
Since, the current market value is less than the intrinsic value; Mr. Z should buy the bond.
Current yield = Annual Interest / Price = 150 / 1025.86 = 14.62% The YTM of the bond is
calculated as follows:
@15%
P = 150 × PVIFA15%, 4 + 1150 × PVIF 15%, 5
= 150 × 2.855 + 1150 × 0.497 = 428.25 + 571.55 = 999.80
@14%
As found in sub part (a) P0 = 1033.80
By interpolation we get,
7.94
= 14%+ × ሺ15%-14%ሻ
7.94-ሺ-26.06ሻ
7.94
= 14%+ %
34
YTM = 14.23%
85
Question 66
Bright Computers Limited is planning to issue a debenture series with a face value of
₹1,000 each for a term of 10 years with the following coupon rates:
Years Rates
1-4 8%
5-8 9%
9-10 13%
The current market rate on similar debenture is 15% p.a. The company proposes to price the
issue in such a way that a yield of 16% compounded rate of return is received by the investors.
The redeemable price of the debenture will be at 10% premium on maturity. What should be
the issue price of debenture?
PV @ 16% for 1 to 10 years are: .862, .743, .641, .552, .476, .410, .354, .305, .263, .227
respectively. May 16 (5 Marks)
Answer:
Present Value of Debenture
Year Cash Outflow (₹) PVF@16% Present Value (₹)
1-4 80 2.798 223.84
5-8 90 1.545 139.05
9-10 130 0.490 63.70
10 1100 0.227 249.70
676.29
Question 67
M/s Agfa Industries is planning to issue a debentures series on the following terms:
Face value ₹100
Term of maturity 10 years
Years Yearly Coupon Rate
1-4 9%
5-8 10%
9-10 14%
The current market rate on similar debentures is 15 per cent per annum. The Company proposes
to price the issue in such a manner that it can yield 16 per cent compounded rate of return to
the investors. The Company also proposes to redeem the debentures at 5 per cent premium on
maturity. Determine the issue price of the debentures. RTP May 20 (New), Practice Manual
86
Answer:
The issue price of the debentures will be the sum of present value of interest payments during
10 years of its maturity and present value of redemption value of debenture
Years Cash Outflow PVIF @16% PV
1 9 0.862 7.758
2 9 0.743 6.687
3 9 0.641 5.769
4 9 0.552 4.968
5 10 0.476 4.76
6 10 0.410 4.10
7 10 0.354 3.54
8 10 0.305 3.05
9 14 0.263 3.682
10 14 + 105 = 119 0.227 3.178 + 23.835
71.327
Thus, the debentures should be priced at ₹71.327
Question 68
ABC Ltd. issued 9%, 5 year bonds of ₹1,000/- each having a maturity of 3 years. The present
rate of interest is 12% for one year tenure. It is expected that Forward rate of interest for one
year tenure is going to fall by 75 basis points and further by 50 basis points for every next year
in further for the same tenure. This bond has a beta value of 1.02 and is more popular in the
market due to less credit risk.
Calculate:
(i) Intrinsic Value of bond.
(ii) Expected price of bond in the market.
Nov 13 (5 Marks), Nov 18 (Old) (5 Marks), MTP Apr 18 (New) (5 Marks), MTP May 20 (New) (8 Marks)
Answer:
(i) Intrinsic value of Bond
PV of Interest + PV of Maturity Value of Bond
Forward rate of interests
1st Year 12%
2nd Year 11.25%
3rd Year 10.75%
87
₹90 ₹90 ₹90

PV of interest = + + = ₹217.81
ሺ1+0.12ሻ ሺ1+0.12ሻሺ1+0.1125ሻ ሺ1+0.12ሻሺ1+0.1125ሻሺ1+0.1075ሻ
₹1000
PV of Maturity Value of Bond = = ₹724.67
ሺ1+0.12ሻሺ1+0.1125ሻሺ1+0.1075ሻ
Intrinsic value of Bond = ₹217.81 + ₹724.67 = ₹942.48
(ii) Expected Price = Intrinsic Value × Beta Value = ₹942.48 × 1.02 = ₹961.33
Question 69
ABC Ltd. wants to issue 9% Bonds redeemable in 5 years at its face value of ₹1,000 each.
The annual spot yield curve for similar risk class of Bond is as follows:
Year Interest Rate
1 12%
2 11.62%
3 11.33%
4 11.06%
5 10.80%
(i) Evaluate the expected market price of the Bond if it has a Beta value of 1.10 due to
its popularity because of lesser risk.
(ii) Interpret the nature of the above yield curve and reasons for the same.
Note: Use PV Factors upto 4 decimal points and value in Rs. upto 2 decimal points.
Answer:
i. For finding expected market price first we shall calculate Value of Bond as follows:
PV of Interest + PV of Maturity Value of Bond
PV of Interest
₹90 ₹90 ₹90 ₹90 ₹90
= + 2
+ 3
+ 4
+ 5
(1+0.12) (1+0.1162) (1+0.1133) (1+0.1106) (1+0.1080)
= ₹90 × 0.8929 + ₹90 × 0.8026 + ₹90 × 0.7247 + ₹90 × 0.6573 + ₹90 × 0.5988
= ₹80.36 + ₹72.23 + ₹65.22 + ₹59.16 + ₹53.89
= ₹330.86
₹1000
PV of Maturity of Bonds = 5
= 1000 x 0.5988 = ₹598.80
(1+0.1080)
Intrinsic value of Bond = ₹330.86 + ₹598.80 = ₹929.66
Expected Price = Intrinsic Value × Beta Value = ₹929.66 × 1.10 = ₹1,022.63

88
ii. The given yield curve is inverted yield curve.

The main reason for this shape of curve is expectation for forthcoming recession when
investors are more interested in Short-term rates over the long term.
Question 70
Pet feed plc has outstanding, a high yield Bond with following features:
Face Value £10,000
Coupon 10%
Maturity Period 6 Years
Special Feature Company can extend the life of Bond to 12 years.
Presently the interest rate on equivalent Bond is 8%.
(a) If an investor expects that interest will be 8%, six years from now then how much he
should pay for this bond now.
(b) Now suppose, on the basis of that expectation, he invests in the Bond, but interest
rate turns out to be 12%, six years from now, then what will be his potential loss/ gain
if company extends the life of bond by another 6 years.
RTP Nov 18 (Old), Practice Manual
Answer:
(a) If the current interest rate is 8%, the company will not extent the duration of Bond and
the maximum amount the investor would ready to pay will be:
= £1,000 PVIAF (8%, 6) + £10,000 PVIF (8%, 6)
= £1,000 × 4.623 + £10,000 × 0.630
= £4,623 + £ 6,300
= £10,923
(b) If the current interest rate is 12%, the company will extent the duration of Bond. After
six years the value of Bond will be
= £1,000 PVIAF (12%, 6) + £10,000 PVIF (12%, 6)
= £1,000 × 4.111 + £10,000 × 0.507
= £4,111 + £5,070
= £9,181
Thus, potential loss will be £9,181 - £10,923 = £1,742
89
Question 71
(a) Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity.
Both the bonds have a face value of ₹1,000 and coupon rate of 8% (with annual interest
payments) and both are selling at par. Assume that the yields of both the bonds fall to 6%,
whether the price of bond will increase or decrease? What percentage of this
increase/decrease comes from a change in the present value of bond’s principal amount
and what percentage of this increase/decrease comes from a change in the present value
of bond’s interest payments? (8 Marks)
(b) Consider a bond selling at its par value of ₹1,000, with 6 years to maturity and a 7% coupon
rate (with annual interest payment), what is bond’s duration? (6 Marks)
(c) If the YTM of the bond in (b) above increases to 10%, how it affects the bond’s duration?
And why? (3 Marks)
(d) Why should the duration of a coupon carrying bond always be less than the time to its
maturity? (3 Marks)
June 09, Practice Manual
Answer:
(a) If the yield of the bond falls the price will always increase. This can be shown by
following calculation.
IF YIELD FALLS TO 6%
Price of 5yr. bond
₹80 (PVIFA 6%, 5yrs.) + ₹1000 (PVIF 6%, 5yrs.)
₹80 (4.212) + ₹1000 (0.747)
₹336.96 + ₹747.00 = ₹1,083.96
Increase in 5 year’s bond price = ₹83.96
Current price of 20 year bond

₹80 (PVIFA 6%, 20) + ₹1,000 (PVIF 6%, 20)
₹80 (11.47) + ₹1,000 (0.312)
₹917.60 + ₹312.00 = ₹1229.60
So, increase in bond price is ₹229.60
PRICE INCREASE DUE TO CHANGE IN PV OF PRINCIPAL

5 yrs. Bond
₹1,000 (PVIF 6%, 5) – ₹1,000 (PVIF 8%, 5)
₹1,000 (0.747) – ₹1,000 (0.681)
₹747.00 – ₹681.00 = ₹66.00
& change in price due to change in PV of Principal
90
(₹66/ ₹83.96) × 100 = 78.6%

20 yrs. Bond
₹1,000 (PVIF 6%, 20) – ₹1,000 (PVIF 8%, 20)
₹1,000 (0.312) – ₹1,000 (0.214)
₹312.00 – ₹ 214.00 = ₹98.00
& change in price due to change in PV of Principal
(₹ 98/ ₹229.60) × 100 = 42.68%
PRICE CHANGE DUE TO CHANGE IN PV OF INTEREST

5 yrs. Bond
₹80 (PVIFA 6%, 5) – ₹80 (PVIFA 8%, 5)
₹80 (4.212) – ₹80 (3.993)
₹336.96 – ₹319.44 = ₹17.52
(₹ 17.52/ ₹83.96) × 100 = 20.86%
20 yrs. Bond
₹80 (PVIFA 6%, 20) – ₹80 (PVIFA 8%,20)
₹80 (11.47) – ₹80 (9.82)
₹917.60 – ₹785.60 = ₹132
(₹ 132/ ₹229.60) × 100 = 57.49%
(b) Duration in the average time taken to recollect back the investment
Years Coupon Redemption Total (₹) PVIF @ 7% (A) × (B) × (C)
(A) Payment (₹) (₹) (B) (₹) (C) (₹)
1 70 - 70 0.935 65.45
2 70 - 70 0.873 122.22
3 70 - 70 0.816 171.36
4 70 - 70 0.763 213.64
5 70 - 70 0.713 249.55
6 70 1000 1070 0.666 4275.72
∑ ABC 5,097.94
∑ABC ₹5097.94
Duration = = = 5.098 years
Purchase Price ₹1,000
91
(c) If YTM goes up to 10%, current price of the bond will decrease to
₹70 × PVIFA (10%,6) + ₹1000 PVIF (10%,6)
₹304.85 + ₹564.00 = ₹868.85
Year Inflow (₹) PVIF @ 10% (A) × (B) × (C)

(A) (B) (C) (₹)
1 70 0.909 63.63
2 70 0.826 115.64
3 70 0.751 157.71
4 70 0.683 191.24
5 70 0.621 217.35
6 1070 0.564 3620.88
∑ ABC 4366.45
New Duration ₹4,366.45/ ₹868.85 = 5.025 years

The duration of bond decreases, reason being the receipt of slightly higher portion of
one’s investment on the same intervals.
(d) Duration is nothing but the average time taken by an investor to collect his/her investment.
If an investor receives a part of his/her investment over the time on specific intervals
before maturity, the investment will offer him the duration which would be lesser than the
maturity of the instrument. Higher the coupon rate, lesser would be the duration.
Question 72
Today being 1st January 2019, Ram is considering to purchase an outstanding Corporate Bond
having a face value of ₹1,000 that was issued on 1st January 2017 which has 9.5% Annual
Coupon and 11 years of original maturity (i.e. maturing on 31st December 2027). Since the bond
was issued, the interest rates have been on downside and it is now selling at a premium of
₹1125.75 per bond.
Determine the prevailing interest on the similar type of Bonds if it is held till the maturity which
shall be at Par.
PV Factors:
1 2 3 4 5 6 7 8 9
6% 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592
8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500
RTP Nov 20 (New), RTP Nov 20 (Old)
92
Answer:
To determine the prevailing rate of interest for the similar type of Bonds we shall compute
the YTM of this Bond using IRR method as follows:
M = ₹1000
Interest = ₹95 (0.095 × ₹1000)
n = 9 years
V0 = ₹1125.75 (₹1,000 + ₹125.75)
YTM can be determined from the following equation
₹95 × PVIFA (YTM, 9) + ₹1000 × PVIF (YTM, 9) = ₹1125.75
Let us discount the cash flows using two discount rates 8% and 10% as follows:
Year Cash Flows PVF@6% PV@6% PVF@8% PV@8%
0 -1125.75 1 -1125.75 1 -1125.75
1 95 0.943 89.59 0.926 87.97
2 95 0.890 84.55 0.857 81.42
3 95 0.840 79.80 0.794 75.43
4 95 0.792 75.24 0.735 69.83
5 95 0.747 70.97 0.681 64.70
6 95 0.705 66.98 0.630 59.85
7 95 0.665 63.18 0.583 55.39
8 95 0.627 59.57 0.540 51.30
9 1095 0.592 648.24 0.500 547.50
112.37 -32.36
Now we use interpolation formula

112.37
6.00%+ × 2.00%
112.37-(-32.36)
112.37
6.00%+ × 2.00% = 6.00%+1.553%
144.73
YTM = 7.553% say 7.55%
Thus, prevailing interest rate on similar type of Bonds shall be approx. 7.55%
93
Question 73
XYZ Ltd.’s bond (Face Value of ₹1000) with 4 years maturity is currently trading at ₹900 carrying
a coupon rate of 15%. Assuming that the reinvestment rate is 16%, you are required to calculate
Realized Yield to Maturity of the bond.
MTP Sept 14 (8 Marks), MTP April 18 (Old) (8 Marks)
Answer:
We shall compute r* (Realized Yield to Maturity) by using following equation:
PV (1+r*)4 = Future Value of Benefits and Future Value of Benefits shall be computed as
follows:
0 1 2 3 4
Investment (₹) 900
Annual Interest (₹) 150 150 150 150
Compound Factor @ 16% 1.56 1.35 1.16 1.00
Future Value of 234.00 202.50 174.00 150
Intermediate Cash Flows (₹)
Maturity Value (₹) 1000
900 234.00 202.50 174.00 1150.00
Total of Future Benefits 1760.50
Accordingly,
900 (1 + r*)4 = 1760.50
(1 + r*)4 = 1760.50/900
(1 + r*)4 = 1.956
(1 + r*) = (1.183)1/4
r* = 0.183 say 18.30%
Question 74
The following data are available for a bond
Face value ₹1,000
Coupon Rate 16%
Years to Maturity 6
Redemption value ₹1,000
Yield to maturity 17%
94
What is the current market price, duration and volatility of this bond? Calculate the expected
market price, if increase in required yield is by 75 basis points.
Jan 21 (Old) (5 Marks), RTP Nov 11, RTP Nov 12, RTP May 16, Practice Manual
Answer:
(a) Calculation of Market price:
Discount or premium
Coupon interest+ ( )
Years left
TM =
Face Value + Market Value
2
Discount or premium – YTM is more than coupon rate, market price is less than Face
Value i.e. at discount.
Let x be the market price
ሺ1,000-xሻ
160+ ( )
6
0.17 =
1,000+x
2
x = ₹960.26
Alternatively, the candidate may attempt by

160 (PVIAF 17%, 6) + 1,000 (PVIF 17%, 6)
= 160 (3.589) + 1,000 (0.390)
= 574.24 + 390 = 964.24
(b) Duration
Year Cash P.V. @ 17% Proportion of Proportion of bond
flow bond value value × time (years)
1 160 .855 136.80 0.142 0.142
2 160 .731 116.96 0.121 0.246
3 160 .624 99.84 0.103 0.309
4 160 .534 85.44 0.089 0.356
5 160 .456 72.96 0.076 0.380
6 1160 .390 452.40 0.469 2.814
964.40 1.000 4.247
Duration of the Bond is 4.247 years
95
Alternatively, as per Short Cut Method

1+YTM ሺ1+YTMሻ+t(c-YTM)
D= -
YTM cሾሺ1+YTMሻt -1ሿ+YTM
Where, YTM = Yield to Maturity

c = Coupon Rate
t = Years to Maturity
1.17 1.17+6(0.16-0.17)
D= - = 4.24 years
0.17 0.16ሾሺ1.17ሻ6 -1ሿ+0.17
(c) Volatility
Duration 4.247
Volatility of the bonds = = = 3.63%
(1+ yields) 1.17
(d) The expected market price if increase in required yield is by 75 basis points.
= ₹960.26 × .75 (3.63/100) = ₹26.142
Hence expected market price is ₹960.26 – ₹26.142 = ₹934.118
Hence, the market price will decrease
This portion can also be alternatively done as follows
= ₹964.40 × .75 (3.63/100) = ₹26.26
Then the market price will be
= ₹964.40 – ₹26.26 = ₹938.14
Question 75
The following data is available for a bond:
Face Value ₹1,000
Coupon Rate 11%
Years to Maturity 6
Redemption Value ₹1,000
Yield to Maturity 15%
(Round-off your answers to 3 decimals)
Calculate the following in respect of the bond:
(i) Current Market Price.
(ii) Duration of the Bond.
(iii) Volatility of the Bond.
(iv) Expected market price if increase in required yield is by 100 basis points.
(v) Expected market price if decrease in required yield is by 75 basis points.
Nov 15 (5 Marks), RTP May 18 (Old), MTP Apr 19 (New) (8 Marks), Practice Manual
96
Answer:
(i) Calculation of Market Price:
Discount or premium
Coupon Interest+ ( )
Years Left
TM =
Face Value + Market Value
2
Discount or premium – YTM is more than coupon rate, market price is less than
Face Value i.e. at discount.
Let x be the market price
ሺ1000 - xሻ
110+ ( )
6
0.15 =
1000+x
2
x = ₹834.48
Alternatively, it can also be calculated using Tabular Method.
(ii) Duration
Year Cash P.V. @ 15% Proportion of Proportion of
flow bond value bond value × time
(years)
1 110 .870 95.70 0.113 0.113
2 110 .756 83.16 0.098 0.196
3 110 .658 72.38 0.085 0.255
4 110 .572 62.92 0.074 0.296
5 110 .497 54.67 0.064 0.320
6 1110 .432 479.52 0.565 3.39
848.35 1.000 4.570
(iii) Volatility
Duration 4.570
Volatility of the bond = = = 3.974
(1 + yields) 1.15
(iv) The expected market price if increase in required yield is by 100 basis points.
= ₹834.48 × 1.00 (3.974/100)
= ₹33.162
97
Alternatively, this can also be calculated as follows:

₹848.35 × 100 (3.794/100) = 33.71
Hence, expected market price is ₹848.48 – ₹33.71 = 814.77
Thus, the market price will decrease.
(v) The expected market price if decrease in required yield is by 75 basis points.
= ₹834.48 × 0.75 (3.974/100)
= ₹24.87
Hence expected market price is ₹834.48 + ₹24.87 = ₹859.35
Alternatively, this can also be calculated as follows:
848.35 × 0.75 (3.974/100) = 25.29
Hence, expected market price = ₹848.35 + ₹25.29 = ₹873.64
Thus, the market price will increase.
Question 76
The following data are available for a bond:
Face Value ₹10,000 to be redeemed at par on maturity
Coupon rate 8.5 per cent per annum
Years to Maturity 5 years
Yield to Maturity (YTM) 10 per cent
(i) Current market price of the Bond,
(ii) Macaulay’s Duration,
(iii) Volatility of the Bond,
(iv) Convexity of the Bond,
(v) Expected market price, if there is a decrease in the YTM by 200 basis points
(a) By Macaulay’s Duration based estimate
(b) By Intrinsic Value Method.
Given
Years 1 2 3 4 5
PVIF (10%, n) 0.909 0.826 0.751 0.683 0.621
PVIF (8%, n) 0.926 0.857 0.794 0.735 0.681
MTP April 22 (8 Marks), Nov 20 (New) (7 Marks)
Answer:
98
(i) Current Market Price of Bond

= ₹850 (PVIAF 10%, 5) + ₹10,000 (PVIF 10%, 5)
= ₹850 (3.79) + ₹10,000 (0.621) = ₹3,221.50 + ₹6,210 = ₹9,431.5
(ii) Macaulay’s Duration

Year Cash flow P.V. @ 10% Proportion of Proportion of bond
bond value value × time (years)
1 850 0.909 772.65 0.082 0.082
2 850 0.826 702.10 0.074 0.148
3 850 0.751 638.35 0.068 0.204
4 850 0.683 580.55 0.062 0.248
5 10,850 0.621 6,737.85 0.714 3.57
9431.50 1.000 4.252
(iii) Volatility of Bond

Duration 4.252
Volatility of Bonds = = = 3.865
(1+YTM) 1.10
(iv) Convexity of Bond
V+ + V− − 2V0
C=
2 x V0 x ∆y 2
Year Cash flow P.V. @ 8% P.V @12%

1 850 0.926 787.10 0.892 758.20
2 850 0.857 728.45 0.797 677.45
3 850 0.794 674.90 0.712 605.20
4 850 0.735 624.75 0.636 540.60
5 10,850 0.681 7388.85 0.567 6,151.95
10204.05 8,733.40
* 10,204.05+8,733.40-2 × 9,431.50 74.45

C = 2
= = 9.867
2 × 9,431.50 × (0.02) 7.5452
Convexity of Bond = 9.867 × (0.02)2 × 100 = 0.395%
99
(v) The expected market price if decrease in YTM by 200 basis points.
(a) By Macaulay’s duration-based estimate

= ₹9431.50 × 2 (3.865/100) = ₹729.05
Hence expected market price is ₹9431.50+₹729.05 = ₹10,160.55
Hence, the market price will increase.
(b) By Intrinsic Value method

Intrinsic Value at YTM of 10% ₹9,431.50
Intrinsic Value at YTM of 8% ₹10,204.05
Price increased by ₹772.55
Hence, expected market price is ₹10,204.05
Question 77
Following is the information for the free options bond:
Face value of the bond ₹1,000
Coupon rate 7%
Terms of Maturity 7 years
Yield to Maturity 8%

(i) Market price of the bond and duration.
(ii) If there is an increase in yield by 35 basis points, what would be the price of bond?
Present Value t1 t2 t3 t4 t5 t6 t7
PVIF0.07,t 0.935 0.874 0.817 0.764 0.714 0.667 0.623
PVIF0.08,t 0.926 0.857 0.794 0.735 0.681 0.631 0.584
Jan 21 (Old) 5 Marks, RTP May 22
Answer:
(i)
(1) Market price and duration of Bond
= 70 (PVIAF 8%,7) + 1,000 (PVIF 8%,7)
= 70 (5.208) + 1,000 (0.584)
= 364.56 + 584.00
= 948.56
100
(2) Duration of Bond

Period Cash flow (₹) PVF@8% PV (₹) Prob. Prob. × T
1 70 0.926 64.82 0.0683 0.0683
2 70 0.857 59.99 0.0632 0.1264
3 70 0.794 55.58 0.0586 0.1758
4 70 0.735 51.45 0.0542 0.2168
5 70 0.681 47.67 0.0503 0.2515
6 70 0.631 44.17 0.0466 0.2796
7 1,070 0.584 624.88 0.6588 4.6116
948.56 5.73
(ii) Price of Bond if increase in yield by 35 basis points

Period Cash flow (₹) PVF@8.35% PV (₹)
1 70 0.923 64.61
2 70 0.852 59.64
3 70 0.786 55.02
4 70 0.726 50.82
5 70 0.670 46.90
6 70 0.618 43.26
7 1,070 0.570 609.90
930.15
Alternatively, if the same increase in yield is linked with duration as computed in sub
part (i), then answer will be computed as follows:
Duration 5.73
Volatility of Bond = = = 5.306
1+YTM 1+0.08
The expected market price if increase in yield is by 35 basis points.
= ₹948.56 × 0.35 (5.306/100) = ₹17.62
Hence, the market price will decrease.
101
Question 78
A 5% bond with face value of ₹1000 is being traded in the market at ₹1000. It is redeemable at
par after 10 years. Find out the duration of the bond if the required rate of return or YTM of the
investor is 5%. Also find out the duration by short-cut method?
Answer:
a)
∑PV × yr 808820
D= = = 8.10 years
∑PV 998.05
Macaulay’s Duration
Yr CF PVF @5% PV PV × Yr
1 50 0.952 47.6 47.6
2 50 0.907 45.35 90.7
3 50 0.864 43.2 129.60
4 50 0.823 41.15 164.60
5 50 0.784 39.2 196
6 50 0.746 37.3 223.80
7 50 0.711 35.55 248.85
8 50 0.677 33.85 270.80
9 50 0.645 32.25 290.25
10 1050 0.612 642.6 6426
998.05 8088.20
b) Duration by Short Cut Method:

1+YTM ሺ1+YTMሻ+t(C-YTM)
D= -
YTM Cൣ(1+YTM)t -1൧+YTM
1.05 1.05+10
= -
0.05 Cሾሺ1+YTMሻt -1ሿ+YTM
1.05
= 21-
0.081
= 21-12.96
= 8.04 Years
102
Question 79
An investor has recently purchased substantial number of 7 years 6.75% ₹1,000 bond with 5%
premium payable on maturity at a required Yield to Maturity (YTM) of 9%. However, due to a
financial crunch he is looking to sell these bonds and has got a proposal from another investor,
who is willing to purchase these bonds by selling out a maximum amount of ₹897 per bond.
Investors follow intrinsic value method for valuation of bonds.
(i) You are required to determine
(1) The Market Price, Duration, Volatility of the bond and
(2) Required YTM of the new investor
(ii) What is the relationship between the price of the bond and YTM?
Period (t) 1 2 3 4 5 6 7
PVIF (9%, t) 0.917 0.842 0.772 0.708 0.650 0.596 0.547
Answer:
(i)
1.
(A) Market Price of Bond
= 1000 × 6.75% × (PVIF 9%, 7)
= 67.50 × 5.032 + 1050 × 0.547
= 339.66 + 574.35
= 914.01
(B) Duration of Bond

Year Cash P.V. @ 9% Proportion Proportion of
Flow of Bond Bond Value ×
Value Time (years)
1 67.50 0.917 61.898 0.0677 0.0677
2 67.50 0.842 56.835 0.0622 0.1244
3 67.50 0.772 52.110 0.0570 0.1710
4 67.50 0.708 47.790 0.0523 0.2092
5 67.50 0.650 43.875 0.0480 0.2400
6 67.50 0.596 40.230 0.0440 0.2640
7 1117.50 0.547 611.273 0.6688 4.6816
914.011 5.7579

Alternatively, as per Short Cut Method
D= -
YTM cሾሺ1+YTMሻt -1ሿ++YTM
103
Where
YTM = Yield to Maturity
c = Coupon Rate
1.09 1.09+7ሺ0.0675-0.09ሻ
= -
0.09 0.0675ሾሺ1.09ሻ7 -1ሿ+0.09
= 5.72
(C) Required yield of new investor

= 67.50 PVIAF (r,7) + 1050 × PVIF (r,7)
Now, Let us discount the cash flow by 9%

PV @ 9% = 67.50 × 5.032 + 1050 × 0.547
= 339.66 + 574.35
= 914.01
NPV @ 9% = 914.01- 897 = ₹17.01
Since, NPV of bond is positive,

we need to increase the discount rate say 12%
= 67.50 PVIAF (12%,7) + 1050 × PVIF (12%,7)
= 67.50 × [0.893 + 0.797 + 0.712 + 0.636 + 0.567 + 0.507 + 0.452] + 1050 × 0.452
= 67.50 × 4.564 + 474.60
= 308.07 + 474.60
= 782.67
NPV @ 12% = 782.67 – 897 = - ₹114.33
NPV at LR
Ke = LR+ ×∆r
NPV at LR-NPV at HR
17.01
= 9%+ × 3%
17.01-ሺ-114.33ሻ
17.01
= 9%+ × 3%
131.34
= 9% + 0.39%
= 9.39%
104
(ii) Relationship between the price of the bond & YTM is opposite or inverse
Question 80
Mr. A is planning for making investment in bonds of one of the two companies X Ltd. and Y Ltd.
The detail of these bonds is as follows:
Company Face Value Coupon Rate Maturity Period
X Ltd. ₹10000 6% 5 Years
Y Ltd. ₹10000 4% 5 Years
The current market price of X Ltd.’s bond is ₹10,796.80 and both bonds have same Yield to
Maturity (YTM). Since Mr. A considers duration of bonds as the basis of decision making, you
are required to calculate the duration of each bond and your decision.
RTP May 14, Practice Manual
Answer:
To calculate duration of bond we need YTM, which shall be calculated as follows:
Let us try NPV @ 5%
600 600 600 600 10600
= 1
+ 2
+ 3
+ 4
+ 5
-10,796.80
(1.05) (1.05) (1.05) (1.05) (1.05)
= ₹571.43 + ₹544.22 +₹518.30+ ₹493.62 + ₹8,305.38 – ₹10,796.80

= – ₹363.85
Let us now try NPV @ 4%

600 600 600 600 10,600
= 1
+ 2
+ 3
+ 4
+ 5
-₹10,796.80
(1.04) (1.04) (1.04) (1.04) (1.04)
= ₹576.92 + ₹554.73 + ₹533.40 + ₹512.88 +₹712.43 – ₹10,796.80

= ₹93.56
Let us now use interpolation formula

93.56
= 4%+ × (5%-4%)
93.56-(-363.85)
93.56
= 4%+
(93.56+363.85)
93.56
= 4%+
457.41
= 4.20%
105
Duration of X Ltd.’s Bond

Year Cash P.V @ 4.2% Proportion of bond Proportion of bond
Flow value value × time (years)
1 600 0.9597 575.82 0.0533 0.0533
2 600 0.9210 552.60 0.0512 0.1024
3 600 0.8839 530.34 0.0491 0.1473
4 600 0.8483 508.98 0.0472 0.1888
5 10600 0.8141 8,629.46 0.7992 3.9960
10,797.20 1.0000 4.4878
Duration of the Bond is 4.4878 years say 4.49 years.
Duration of Y Ltd.’s Bond

Year Cash Flow P.V. @4.2% Proportion of Proportion of bond
1 400 0.9597 383.88 0.0387 0.0387
2 400 0.9210 368.40 0.0372 0.0744
3 400 0.8839 353.56 0.0357 0.1071
4 400 0.8483 339.32 0.0342 0.1368
5 10400 0.8141 8,466.64 0.8542 4.2710
9,911.80 1.0000 4.6280
Duration of the Bond is 4.6280 years say 4.63 years.
Decision: Since the duration of Bond of X Ltd. is lower hence it should be preferred.
Question 81
XL Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1, 2007.
These debentures have a face value of ₹100 and is currently traded in the market at a price of
₹90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and December
31. Interest payments for the first 3 years will be paid in advance through post- dated cheques
while for the last 2 years post-dated cheques will be issued at the third year. The bond is
redeemable at par on December 31, 2011 at the end of 5 years.
Required:
(i) CALCULATE the current yield and YTM of the bond.
(ii) CALCULATE the duration of the NCD.
(iii) CALCULATE the realized yield on the NCD assuming that intermediate coupon payments
106
are, not available for reinvestment calculate.
Nov 08 (6 Marks), RTP May 12, RTP May 18 (New), Practice Manual
Answer:
(i)
₹7 12
Current Yield = × = 0.1555 or 15.55%
₹90 6
YTM can be determined from the following equation
7 × PVIFA (YTM, 10) + 100 × PVIF (YTM, 10) = 90
Let us discount the cash flows using two discount rates 7.50% and 9% as follows:
Year Cash PVF@ PV@ PVF@ PV@
Flows 7.50% 7.50% 9% 9%
0 -90 1 -90 1 -90
1 7 0.930 6.51 0.917 6.419
2 7 0.865 6.055 0.842 5.894
3 7 0.805 5.635 0.772 5.404
4 7 0.749 5.243 0.708 4.956
5 7 0.697 4.879 0.650 4.550
6 7 0.648 4.536 0.596 4.172
7 7 0.603 4.221 0.547 3.829
8 7 0.561 3.927 0.502 3.514
9 7 0.522 3.654 0.460 3.220
10 107 0.485 51.90 0.422 45.154
6.560 -2.888

6.560
7.50%+ × 1.50%
6.560-(2.888)
6.560
7.50%+ × 1.50% = 7.50%+1.041%
9.448
YTM = 8.541% say 8.54%
Note: Students can also compute the YTM using rates other than 15% and 18%.
107
(ii) The duration can be calculated as follows:

Year Cash PVF@ PV @ Proportion of NCD Proportion of NCD
Flow 8.54% 8.54% value value × time
1 7 0.921 6.447 0.0717 0.0717
2 7 0.849 5.943 0.0661 0.1322
3 7 0.782 5.474 0.0608 0.1824
4 7 0.721 5.047 0.0561 0.2244
5 7 0.664 4.648 0.0517 0.2585
6 7 0.612 4.284 0.0476 0.2856
7 7 0.563 3.941 0.0438 0.3066
8 7 0.519 3.633 0.0404 0.3232
9 7 0.478 3.346 0.0372 0.3348
10 107 0.441 47.187 0.5246 5.2460
89.95 7.3654
Duration = 7.3654 half years i.e. 3.683 years.
(iii) Realized Yield can be calculated as follows:

ሺ7 × 10ሻ+100
10
= 90
(1+R)
10 170
(1+R) =
90
1
170 10
R=( ) -1 = 0.06380 or 6.380% for half yearly and 12.76% annually
90
Question 82
Find the current market price of a bond having face value ₹1,00,000 redeemable after 6 year
maturity with YTM at 16% payable annually and duration 4.3202 years. Given 1.166 = 2.4364.
Practice Manual
Answer:
The formula for the duration of a coupon bond is as follows:
D= -
YTM cሾሺ1+YTMሻt -1ሿ+YTM
Where YTM = Yield to Maturity
c = Coupon Rate
108
Accordingly, since YTM = 0.16 and t = 6

1.16 1.16+6(c 0.16)
4.3202 = -
0.16 cሾሺ1.16ሻ6 -1ሿ+0.16
1.16+(6c- 0.96)
4.3202 = 7.25-
1.4364c+0.16
1.16+6c- 0.96
= 2.9298
1.4364c+0.16
0.2 + 6c = 4.20836472 c + 0.468768
1.79163528c = 0.268768
c = 0.150012674
c = 0.15
Where c = Coupon rate

Therefore, current price
= ₹(1,00,000/- × 0.15 × 3.685 + 1,00,000/- × 0.410) = ₹96,275/-

Let x be annual coupon payment. Accordingly, the duration (D) of the Bond shall be
Year CF PVIF 16% PV (CF) PV(CF) x year
PV (CF)
1 X 0.862 0.862x 0.862x
2 X 0.743 0.743x 1.486x
3 X 0.641 0.641x 1.923x
4 X 0.552 0.552x 2.208x
5 X 0.476 0.476x 2.38x
6 X +100000 0.410 0.410x + 41000 2.46x + 246000
3.684x + 41000 11.319x +246000
11.319x+246000
4.3202 =
3.684x+41000
x = ₹14,983 i.e. 14.98% say 15%
Accordingly, current price of the Bond shall be:

= 1,00,000 × 0.15 × PVAF (16%, 6) + 1,00,000 × PVF (16%, 6)
= 15,000 × 3.685 + 1,00,000 × 0.410
= ₹96,275
109
Question 83
Mr. A will need ₹1,00,000 after two years for which he wants to make one, time necessary
investment now. He has a choice of two types of bonds. Their details are as below:
Bond X Bond Y
Face value ₹1,000 ₹1,000
Coupon 7% payable annually 8% payable annually
Years to maturity 1 4
Current price ₹972.73 ₹936.52
Current yield 10% 10%
Advice Mr. A whether he should invest all his money in one type of bond or he should buy both
the bonds and, if so, in which quantity? Assume that there will not be any call risk or default
risk.
MTP March 22 (8 Marks), RTP Nov 21 (New), RTP Nov 21 (Old), Nov 15 (6 Marks), MTP Aug 18 (New) (6
Marks), MTP Oct 19 (Old) (8 Marks), Practice Manual, StudyMat
Answer:
Duration of Bond X
flow bond value value × time (years)
1 1070 .909 972.63 1.000 1.000
Duration of the Bond is 1 year
Duration of Bond Y
Year Cash P.V. @ 10% Proportion of Proportion of bond value ×
flow bond value time (years)
1 80 .909 72.72 0.077 0.077
2 80 .826 66.08 0.071 0.142
3 80 .751 60.08 0.064 0.192
4 1080 .683 737.64 0.788 3.152
936.52 1.000 3.563
Duration of the Bond is 3.563 year
110
Let x1 be the investment in Bond X and therefore investment in Bond Y shall be (1– x1).
Since the required duration is 2 year the proportion of investment in each of these two
securities shall be computed as follows:
2 = x1 + (1 – x1) 3.563
x1 = 0.61
Accordingly, the proportion of investment shall be 61% in Bond X and 39% in Bond Y
respectively.
Amount of investment
Bond X Bond Y
PV of ₹1,00,000 for 2 years @ 10% × 61% PV of ₹1,00,000 for 2 years @ 10% × 39%
= ₹1,00,000 (0.826) × 61% = ₹1,00,000 (0.826) × 39%
= ₹50,386 = ₹32,214
No. of Bonds to be purchased No. of Bonds to be purchased
= ₹50,386/₹972.63 = 51.80 = ₹32,214/ ₹936.52 = 34.40
i.e. approx. 52 bonds i.e. approx. 34 bonds
Note: The investor has to keep the money invested for two years. Therefore, the investor
can invest in both the bonds with the assumption that Bond X will be reinvested for another
one year on same returns.
Further, in the above computation, Modified Duration can also be used instead of Duration.
111
Question 84
G holds securities as detailed herein below:
Security Face Numbers Coupon Maturity Annual
Value (₹) Rate (%) Years Yield (%)
(i) Bond A 1,000 100 9 3 12
(ii) Bond B 1,000 100 10 5 12
(iii) Preference Shares C 100 1,000 11 * 13*
(iv) Preference Shares D 100 1,000 12 * 13*
* Likelihood of being called (redeemed) at a premium over par.

Compute the current value of G’s portfolio. RTP May 17
Answer:
Computation of current value of G’s portfolio
(i) 100 Nos. Bond A, ₹1,000 par value, 9% Bonds maturity 3 years: 92,818
Current value of interest on bond A
1-3 years: ₹9000 × Cumulative P.V. @ 12% (1-3 years) 21,618
= ₹9000 × 2.402
Add: Current value of amount received on maturity of Bond A
End of 3rd year: ₹1,000 × 100 × P.V. @ 12% (3rd year) 71,200
= ₹1,00,000 × 0.712
(ii) 100 Nos. Bond B, ₹1,000 par value, 10% Bonds maturity 5 years: 92,750
Current value of interest on bond B
1-5 years: ₹10,000 × Cumulative P.V. @ 12% (1-5 years)
= ₹10,000 × 3.605 36,050
Add: Current value of amount received on maturity of Bond B
End of 5th year: ₹1,000 × 100 × P.V. @ 12% (5th year) 56,700
= ₹1,00,000 × 0.567
(iii) 1000 Preference shares C, ₹100 par value, 11% coupon 84,615
11% × 1000Nos. × ₹100 11,000
=
13% 0.13
(iv) 1000 Preference shares D, ₹100 par value, 12% coupon 92,308
12% × 1000Nos. × ₹100 12,000
=
13% 0.13
Total current value of his portfolio [(i) + (ii) + (iii) + (iv)] 3,62,491
112
Question 85
John inherited the following securities on his uncle’s death:
Types of Security Nos. Annual Coupon % Maturity Years Yield %
Bond A (₹1,000) 10 9 3 12
Bond B (₹1,000) 10 10 5 12
Preference shares C (₹100) 100 11 * 13*
Preference shares D (₹100) 100 12 * 13*
*likelihood of being called at a premium over par.
Tax Rate applicable on John is 20% and dividend incomes are tax free. Compute the current
value of his uncle’s portfolio.
MTP Oct 14 (10 Marks), Practice Manual
Answer:
Computation of current value of John’s portfolio ₹
(i) 10 Nos. Bond A, ₹1,000 par value, 9% Bonds maturity 3 years:
Current value of interest on bond A 8,849
1-3 years: ₹900(1–0.20) × Cumulative P.V. @ 12% (1-3 years)
= ₹720 × 2.402 1729
Add: Current value of amount received on maturity of Bond A
End of 3rd year: ₹1,000 × 10 × P.V. @ 12% (3rd year)
= ₹10,000 × 0.712 7120
(ii) 10 Nos. Bond B, ₹1,000 par value, 10% Bonds maturity 5 years:
Current value of interest on bond B
1-5 years: ₹1,000(1–0.20) × Cumulative P.V. @ 12% (1-5 years)
= ₹800 × 3.605 2,884
Add: Current value of amount received on maturity of Bond B
End of 5th year: ₹1,000 × 10 × P.V. @ 12% (5th year)
= ₹10,000 × 0.567 5,670 8,554
(iii) 100 Preference shares C, ₹100 par value, 11% coupon 8,462
= 11% × 100 Nos. × ₹100
13%
(iv) 100 Preference shares D, ₹100 par value, 12% coupon
= 12% × 100 Nos. × ₹100 9,231
13%
Total Current value of his portfolio [(i) + (ii) + (iii) + (iv)] ₹35,096
113
Question 86
A bond is currently trading for 98.722 per 100 of par value. If the bond’s yield-to-maturity (YTM)
rises by 10 basis points, the bond’s full price is expected to fall to 98.669. If the bond’s YTM
decreases by 10 basis points, the bond’s full price is expected to increase to 98.782. Calculate
the bond’s approximate convexity.
Answer:
P0 = 98.722 , P+ = 98.669, P- = 98.782
Δy = 10bp (0.001)
P+ +P- -2P0
Convexity =
2P0 × Δy2
98.669+98.782-2ሺ98.722ሻ
=
2 × 98.722 × ሺ0.001ሻ2
0.007
=
0.0001974
Convexity = 35.46
Question 87
A bond has an annual modified duration of 7.020 and annual convexity of 65.180. If the bond’s
yield-to-maturity decreases by 25 basis points, what is the expected percentage price change
Answer:
% ΔMP = -[AnnModDur × Δy] + [Convexity × Δy2]
= - [7.020 × (-0.0025)] + [65.180 × (0.0025)2]
= 0.01755 + 0.00041
= 0.01796
% Δ MP = 1.796% ↑
Question 88
A bond has an annual modified duration of 7.140 and annual convexity of 66.200. The bond’s
yield-to-maturity is expected to increase by 50 basis points. What is the expected percentage
price change?
Answer:
% ΔMP = -[AnnModDur × Δy] + [Convexity × Δy2]
= - [7.140 × (0.0050)] + [66.20 × (0.0050)2]
= -0.0357 + 0.001655
= - 0.034045
% ΔMP = 3.40%↓
114
Question 89
Based on the following price information for four bonds and assuming that all four bonds are
trading to yield 5%:
Coupon 5.0% 5.0% 8.0% 8.0%
Yield Maturity 4 25 4 25
3.00% 107.4859 134.9997 118.7148 187.4992
4.00% 103.6627 115.7118 114.6510 162.8472
4.50% 101.8118 107.4586 112.6826 152.2102
4.75% 100.9011 103.6355 111.7138 147.2621
4.90% 100.3593 101.4324 111.1374 144.4042
5.00% 100.0000 100.0000 110.7552 142.5435
5.10% 99.6423 98.5959 110.3746 140.7175
5.25% 99.1085 96.5416 109.8066 138.0421
5.50% 98.2264 93.2507 108.8679 133.7465
6.00% 96.4902 87.1351 107.0197 125.7298
7.00% 93.1260 76.5444 103.4370 111.7278
Percentage price change based on an initial yield of 5%

Coupon 5.00% 5.00% 8.00% 8.00%
Yield Maturity 4 25 4 25
3.00% 7.49% 35.00% 7.19% 31.54%
4.00% 3.66% 15.71% 3.52% 14.24%
4.50% 1.81% 7.46% 1.74% 6.78%
4.75% 0.90% 3.64% 0.87% 3.31%
4.90% 0.36% 1.43% 0.35% 1.31%
5.00% 0.00% 0.00% 0.00% 0.00%
5.10% −0.36% −1.40% −0.34% −1.28%
5.25% -0.89% -3.46% -0.86% -3.16%
5.50% -1.77% -6.75% -1.70% -6.17%
6.00% -3.51% -12.86% -3.37% -11.80%
7.00% -6.87% -23.46% -6.61% -21.62%
1. Assuming all four bonds are selling to yield 5%, compute the value for C in the convexity
equation for each bond using a 25 basis point rate shock (0.0025)
115
2. Using the value for C computed in Part 1, compute the convexity adjustment for the two 25-
year bonds assuming that the yield changes by 200 basis points (0.02).
3. Compute the estimated percentage price change using duration 14.19 (5%y yield, 25 year)
& 12.94 (8% yield 25 year) and convexity adjustment if yield changes by 200 basis points.
Answer:
1.
P+ +P- -2P0
Convexity =
2P0 × Δy2
5% 4Yr 5% 25yr 8% 4Yr 8% 25yr
P+ 99.1085 96.5416 109.8066 138.0421
P- 100.9011 103.6355 111.7138 147.2621
P0 100 100 110.7552 142.5435
Numerator 0.0096 0.1771 0.01 0.2172
Denominator 0.00125 0.00125 0.00138 0.00178
Convexity 7.68 141.68 7.25 122.02
2. Convexity Adjustment = [Convexity × Δy2]
5%, 25 year Bond = 141.68 × (0.02)2 = 0.0567 i.e.5.67%
8%, 25 year Bond = 122.02 × (0.02)2 = 0.0488 i.e.4.88%
3. % ΔMP = -[AnnModDur × Δy] + [Convexity × Δy2]

Bond Δ Yield % Δ MP
5%, 25 year -0.02 = -[14.19 × (-0.02)] + [0.0567] = 34.05%
5%, 25 year 0.02 = -[14.19 × 0.02] + [0.0567] = -22.71%
8%, 25 year -0.02 = -[12.94 × (-0.02)] + [0.0488] = 30.76%
8%, 25 year 0.02 = -[12.94 × 0.02] + [0.0488] = -21.00%
Question 90
The following data are available for three bonds A, B and C. These bonds are used by a bond
portfolio manager to fund an outflow scheduled in 6 years. Current yield is 9%. All bonds have
face value of ₹100 each and will be redeemed at par. Interest is payable annually.
Bond Maturity (Years) Coupon rate
A 10 10%
B 8 11%
C 5 9%
116
(i) Calculate the duration of each bond.

(ii) The bond portfolio manager has been asked to keep 45% of the portfolio money in
Bond A. Calculate the percentage amount to be invested in bonds B and C that need
to be purchased to immunize the portfolio.
(iii) After the portfolio has been formulated, an interest rate change occurs, increasing the
yield to 11%. The new duration of these bonds are: Bond A = 7.15 Years, Bond B =
6.03 Years and Bond C = 4.27 years. Is the portfolio still immunized? Why or why not?
(iv) Determine the new percentage of B and C bonds that are needed to immunize the
portfolio. Bond A remaining at 45% of the portfolio
Present values be used as follows:
PVIF0.09,t 0.917 0.842 0.772 0.708 0.650

PVIF0.09,t 0.596 0.547 0.502 0.460 0.4224
Nov 18 (New) (12 Marks), MTP May 20 (12 Marks), MTP March 21 (New) (12 Marks)
Answer:
(i) Calculation of Bond Duration
Bond A
Year Cash flow P.V. @ 9% Proportion of Proportion of bond
bond value value time (years)
1 10 0.917 9.17 0.086 0.086
2 10 0.842 8.42 0.079 0.158
3 10 0.772 7.72 0.073 0.219
4 10 0.708 7.08 0.067 0.268
5 10 0.650 6.50 0.061 0.305
6 10 0.596 5.96 0.056 0.336
7 10 0.547 5.47 0.051 0.357
8 10 0.502 5.02 0.047 0.376
9 10 0.460 4.60 0.043 0.387
10 110 0.4224 46.46 0.437 4.370
106.40 1.000 6.862
Duration of the bond is 6.862 years or 6.86 year
117
Bond B
flow bond value value time (years)
1 11 0.917 10.087 0.091 0.091
2 11 0.842 9.262 0.083 0.166
3 11 0.772 8.492 0.076 0.228
4 11 0.708 7.788 0.070 0.280
5 11 0.650 7.150 0.064 0.320
6 11 0.596 6.556 0.059 0.354
7 11 0.547 6.017 0.054 0.378
8 111 0.502 55.772 0.502 4.016
111.224 1.000 5.833
Duration of the bond B is 5.833 years or 5.84 years.
Bond C
flow bond value value time (years)
1 9 0.917 8.253 0.082 0.082
2 9 0.842 7.578 0.076 0.152
3 9 0.772 6.948 0.069 0.207
4 9 0.708 6.372 0.064 0.256
5 109 0.650 70.850 0.709 3.545
100.00 1.000 4.242
Duration of the bond C is 4.242 years or 4.24 years
(ii) Amount of Investment required in Bond B and C

Period required to be immunized 6.000 Year
Less: Period covered from Bond A 3.087 Year
To be immunized from B and C 2.913 Year
Let proportion of investment in Bond B and C is b and c respectively then

b + c = 0.55 (1)
5.883b + 4.242c = 2.913 (2)
On solving these equations, the value of b and c comes 0.3534 or 0.3621 and 0.1966
or 0.1879 respectively and accordingly, the % of investment of B and C is 35.34% or
118
36.21% and 19.66 % or 18.79% respectively.
(iii) With revised yield the Revised Duration of Bond stands

0.45 × 7.15 + 0.36 × 6.03 + 0.19 × 4.27 = 6.20 year
No portfolio is not immunized as the duration of the portfolio has been increased from
6 years to 6.20 years.
(iv) New percentage of B and C bonds that are needed to immunize the portfolio.
Period required to be immunized 6.0000 Year
Less: Period covered from Bond A 3.2175 Year
To be immunized from B and C 2.7825 Year
Let proportion of investment in Bond B and C is b and c respectively, then

b + c = 0.55
6.03b + 4.27c = 2.7825
b = 0.2466
On solving these equations, the value of b and c comes 0.2466 and 0.3034 respectively
and accordingly, the % of investment of B and C is 24.66% or 25% and 30.34 % or
30.00% respectively.
Question 91
Firm XYZ is required to make a $5M payment in 1 year and a $4M payment in 3 years. The yield
curve is flat at 10% APR with semiannual compounding. Firm XYZ wants to form a portfolio
using 1-year and 4-year U.S. strips to fund the payments. How much of each strip must the
portfolio contain for it to still be able to fund the payments after a shift in the yield curve?
Answer:
$5M
1 year = = $4.535M
ሺ1.05ሻ2
$4M
3 year = = $2.985M
ሺ1.05ሻ6
∴PV of Liabilities = $7.52 M

∴PV of Assets = $7.52 M
4.535 2.985
Average Investors Horizon = 1 × ൤ ൨ +3 × ൤ ൨ = 0.6031 + 1.1908. = 1.7939 years
7.52 7.52
119
For Immunised Portfolio,

Duration = Investors Horizon
∴Duration = 1.7939 Year
∑Wi Di = 1.7939
WA DA + WB DB = 1.7939
WA × 1 + [1 - WA] × 4 = 1.7939
WA + 4 - 4WA = 1.7939
3WA = 2.2061
WA = 0.7354 (73.54%)
WB = 1 – 0.7354
WB = 0.2646 (26.46%)
∴ Immunized Bond Portfolio Investment

1 year Bond 7.52 × 73.54% = $5.53M
4 year Bond 7.52 × 26.46% = $1.99M
$7.52M
Question 92
Sabanam Ltd. has issued convertible debentures with coupon rate 11%. Each debenture has
an option to convert to 16 equity shares at any time until the date of maturity. Debentures will
be redeemed at ₹100 on maturity of 5 years. An investor generally requires a rate of return of
8% p.a. on a 5-year security. As an advisor, when will you advise the investor to exercise
conversion for given market prices of the equity share of- (i) ₹5 (ii) ₹6 (iii) ₹7.10.
Cumulative PV factor for 8% for 5 years : 3.993
PV factor for 8% for year 5 : 0.681
May 18 (New) (6 Marks), Practice Manual, StudyMat
Answer:
If Debentures are not converted its value is as under:
PVF @ 8 % ₹
Interest - ₹11 for 5 years 3.993 43.923
Redemption - ₹100 in 5th year 0.681 68.100
112.023
120
Value of equity shares:

Market Price No. Total (₹)
₹5 16 80
₹6 16 96
₹7.10 16 113.60
Hence, unless the market price is ₹7.10 conversion should not be exercised.
Question 93
Suppose Mr. A is offered a 10% Convertible Bond (par value ₹1,000) which either can be
redeemed after 4 years at a premium of 5% or get converted into 25 equity shares currently
trading at ₹33.50 and expected to grow by 5% each year. You are required to determine the
minimum price Mr. A shall be ready to pay for bond if his expected rate of return is 11%.
RTP May 15
Answer:
First, we shall find the Conversion Value of Bond
CV = C (1+g)n × R
Where:
C = Current Market Price
g = Growth Rate of Price
R = Conversion Ratio
n = No. of years
Accordingly, CV shall be = ₹33.50 × 1.054 × 25 = ₹33.50 × 1.2155 × 25 = ₹1017.98

Value of Bond if Conversion = ₹100 × PVAF (11%, 4) + ₹1017.98 PVF (11%,4)
is opted
= ₹100 × 3.102 + ₹1017.98 × 0.659
= ₹310.20 + ₹670.85
= ₹981.05
Since above value of Bond is based on the expectation of growth in market price which may
or may not be as per expectations. In such circumstances the redemption at premium still
shall be guaranteed and bond may be purchased at its floor value computed as follows:
Value of Bond if = ₹100 × PVAF (11%, 4) + ₹1050 PVF (11%,4)
Conversion is not opted
= ₹100 × 3.102 + ₹1050 × 0.659
= ₹310.20 + ₹691.95
= ₹1002.15
121
Question 94
The data given below relates to convertible bond of Hi-Fi Ltd.:
Face value ₹2,500
No. of shares per bond 20
Coupon rate 12%
Market price per share ₹120
Market price of convertible bond ₹2,650
Straight value of bond ₹2,350
You are required to calculate the following:

(i) Conversion value of bond.
(ii) The percentage of downside risk.
(iii) The conversion premium
(iv) Conversion parity price of the stock and also interpret the results.
July 21 (New) (8 Marks), Nov 08 (8 Marks), RTP Nov 15, RTP Nov 17, MTP Apr 18
(New) (7 Marks), RTP May 19 (Old), MTP Oct 15 (8 Marks), Practice Manual
Answer:
(i) Stock value or conversion value of bond
120 × 20 = ₹2,400
(ii) Percentage of the downside risk
₹2,650 - ₹2,350 ₹2,650 - ₹2,350
== 0.1277 or 12.77% or = 0.1132 or 11.32%
₹2,350 ₹2,650
This ratio gives the percentage price decline experienced by the bond if the stock
becomes worthless.
(iii) Conversion Premium

Market Price-Conversion Value
×100
Conversion Value
₹2,650 - ₹2,400
=10.42
₹2,400
(iv) Conversion Parity Price

Bond Price ₹2,650
= =₹132.50
No. of Shares on Conversion 20
This indicates that if the price of shares rises to ₹132.50 from ₹120 the investor
will neither gain nor lose on buying the bond and exercising it. Observe that ₹12.50
(₹132.50 – ₹120.00) is 10.42% of ₹120, the Conversion Premium.
122
Question 95
XYZ company has current earnings of ₹3 per share with 5,00,000 shares outstanding. The
company plans to issue 40,000, 7% convertible preference shares of ₹50 each at par. The
preference shares are convertible into 2 shares for each preference shares held. The equity
share has a current market price of ₹21 per share.
(i) What is preference share’s conversion value?
(ii) What is conversion premium?
(iii) Assuming that total earnings remain the same, calculate the effect of the issue on the
basic earnings per share (a) before conversion (b) after conversion.
(iv) If profits after tax increases by ₹1 million what will be the basic EPS
(a) before conversion and
(b) on a fully diluted basis?
Nov 09 (8 Marks), May 17 (8 Marks), MTP March 19 (Old) (8 Marks), Practice Manual
Answer:
(i) Conversion value of preference share
Conversion Ratio × Market Price = 2 × ₹21 = ₹42
(ii) Conversion Premium

(₹50/ ₹42) – 1 = 19.05%
(iii) Effect of the issue on basic EPS

₹
Before Conversion
Total (after tax) earnings ₹3 × 5,00,000 15,00,000
Dividend on Preference shares 1,40,000
Earnings available to equity holders 13,60,000
No. of shares 5,00,000
EPS 2.72
On Diluted Basis
Earnings 15,00,000
No of shares (5,00,000 + 80,000) 5,80,000
EPS 2.59
123
(iv) EPS with increase in Profit
₹
Before Conversion
Earnings 25,00,000
Dividend on Pref. shares 1,40,000
Earning for equity shareholders 23,60,000
No. of equity shares 5,00,000
EPS 4.72
On Diluted Basis
Earnings 25,00,000
No. of shows 5,80,000
EPS 4.31
Question 96
The following data is related to 8.5% Fully Convertible (into Equity shares) Debentures issued
by JAC Ltd. at ₹1000.
Market Price of Debenture ₹900
Conversion Ratio 30
Straight Value of Debenture ₹700
Market Price of Equity share on the date of Conversion ₹25
Expected Dividend Per Share ₹1

(a) Conversion Value of Debenture
(b) Market Conversion Price
(c) Conversion Premium per share
(d) Ratio of Conversion Premium
(e) Premium over Straight Value of Debenture
(f) Favorable income differential per share
(g) Premium pay back period
MTP April 22 (10 Marks), RTP Nov 21(New), RTP Nov 21(Old), May 18 (Old) (8 Marks), RTP Nov
12, RTP May 13, RTP May 15, RTP Nov 16, MTP Aug 18 (Old) (8 Marks), Practice Manual
Answer:
124
(a) Conversion Value of Debenture

= Market Price of One Share × Conversion Ratio
= ₹25 × 30 = ₹750
(b) Market Conversion Price

Market Price of Convertible Debenture 900
= = = ₹30
Conversion Ratio 30
(c) Conversion Premium per share

= Market Conversion Price – Market Price of Equity Share
= ₹30 - 25 = ₹5
(d) Ratio of Conversion Premium

Conversion premium per share ₹5
= = = 20%
Market Price of Equity Share ₹25
(e) Premium over Straight Value of Debenture

Market Price of Convertible Bond 900
= -1 = -1 = 28.6%
Straight Value of Bond 700
(f) Favorable income differential per share

Coupon Interest from Debenture - Conversion Ratio × Dividend Per Share
=
Conversion Ratio
85-30 × 1
=
30
= ₹1.833
(g) Premium pay back period

Conversion Premium per share
=
Favorable Income Differential per share
₹5
=
₹1.833
= 2.73 years
125
Question 97
Pineapple Ltd has issued fully convertible 12 percent debentures of ₹5,000 face value,
convertible into 10 equity shares. The current market price of the debentures is ₹5,400. The
present market price of equity shares is ₹430.
Calculate:
(i) the conversion percentage premium, and
(ii) the conversion value
Answer:
(i) As per the conversion terms 1 Debenture = 10 equity share and since face value of one
debenture is ₹5000 the value of equity share becomes ₹500 (5000/10).
The conversion terms can also be expressed as: 1 Debenture of ₹500 = 1 equity share.
The cost of buying ₹500 debentures (one equity share) is:
5400
₹500 × = ₹540
5000
Market Price of share is ₹430. Hence conversion premium in percentage is:

540-430
× 100 = 25.58%
430
(ii) The conversion value can be calculated as follows:
Conversion value = Conversion ratio × Market Price of Equity Shares
= 10 × ₹430 = ₹4300
Question 98
A convertible bond with a face value of ₹1,000 is issued at ₹1,350 with a coupon rate of 10.5%.
The conversion rate is 14 shares per bond. The current market price of bond and share is ₹1,475
and ₹80 respectively. What is the premium over conversion value?
Practice Manual
Answer:
Conversion rate is 14 shares per bond.
Market price of share ₹80
Conversion Value 14 × ₹80 = ₹1120
Market price of bond = ₹1475
335
Premium over Conversion Value ሺ₹1475-₹1120ሻ = × 100 = 31.7%
1120
126
Question 99
GHI Ltd., AAA rated company has issued, fully convertible bonds on the following terms, a year
ago:
Face value of bond ₹1000
Coupon (interest rate) 8.5%
Time to Maturity (remaining) 3 years
Interest Payment Annual, at the end of year
Principal Repayment At the end of bond maturity
Conversion ratio (Number of shares per bond) 25
Current market price per share ₹45
Market price of convertible bond ₹1175
AAA rated company can issue plain vanilla bonds without conversion option at an interest rate
of 9.5%.
Required: Calculate as of today:
(i) Straight Value of bond.
(ii) Conversion Value of the bond.
(iii) Conversion Premium.
(iv) Percentage of downside risk.
(v) Conversion Parity Price.
T 1 2 3
PVIF0.095, t 0.9132 0.8340 0.7617
May 14 (8 Marks), RTP May 17, MTP Aug 18 (New) (8 Marks), Practice Manual
Answer:
(i) Straight Value of Bond
= ₹85 × 0.9132 + ₹85 × 0.8340 + ₹1085 × 0.7617
= ₹974.96
(ii) Conversion Value

Conversion Ratio × Market Price of Equity Share
= ₹45 × 25
= ₹1,125
(iii) Conversion Premium

Conversion Premium = Market Conversion Price - Market Price of Equity Share
127
₹1,175
= -₹45 = ₹2
25
or = ₹1,175-₹45 × 25 = ₹50
₹1,175-₹1,125
or = 4.47%
₹1,125
(iv) Percentage of Downside Risk

₹1,175-974.96
= × 100 = 20.52%
₹974.96
₹1,175-₹974.96
or = 17.02%
₹1,175
(v) Conversion Parity Price

Bond Price ₹1175
= = ₹47
No. of Share on conversion 25
Question 100
B International Ltd. (BIL) has purchased 5 years 15.28% convertible debentures on 1.04.2021.
The convertible debentures will mature on 31.03.2026. Each debenture can be converted into
20 equity shares of face value of ₹1 at any point of time but before maturity. Debentures will be
redeemed at ₹100 on maturity.
The required rate of return of BIL is 10% per annum on a 5-year security.
The Reputed, a consultant has projected the following behavior of the shares:
Period Price Range
From To Passive Most likely Optimistic
1.04.2021 31.12.2022 4 4.5 5
1.01.2023 30.06.2025 4.5 6.5 7
1.07.2025 31.03.2026 3.5 5 5.5
BIL, as a matter of policy, rounds up the amount.
(a) The break-even price at which the debentures can be converted
(b) The ideal period in which BIL shall convert and dispose of the shares.
Given:
PVIF (10%, 5) 0.6209
PVIFA (10%, 5) 3.7908
Dec 21 (Old) (5 Marks)
128
Answer:
(i) The Break-even price at which Debenture can be converted shall be equivalent to
Present Value of stream of cash flows from holding debenture till maturity and it shall be
computed as follows:
PV = ₹15.28 × PVIFA (10%,5) + ₹100 × PVIF (10%,5)
= ₹15.28 × 3.7908+ ₹100 × 0.6209
= ₹57.92 + ₹62.09 = ₹120.01 say ₹120
₹120
Thus, Break Even Price= =₹6/- per share
₹20
(ii) The ideal period in which BIL should convert and dispose of share will be 01.01.23 to
30.06.25 as during this period the market price of share is most likely to exceed its Break-
even price.
Question 101
A Ltd. has issued convertible bonds, which carries a coupon rate of 14%. Each bond is
convertible into 20 equity shares of the company A Ltd. The prevailing interest rate for similar
credit rating bond is 8%. The convertible bond has 5 years maturity. It is redeemable at par at
₹100.
The relevant present value table is as follows.
Present values t1 t2 t3 t4 t5
PVIF0.14, t 0.877 0.769 0.675 0.592 0.519
PVIF0.08, t 0.926 0.857 0.794 0.735 0.681
You are required to estimate:

(Calculations be made up to 3 decimal places)
(i) current market price of the bond, assuming it being equal to its fundamental value,
(ii) minimum market price of equity share at which bond holder should exercise conversion
option; and
(iii) duration of the bond.
Nov 16 (5 Marks), RTP May 19 (Old), MTP Oct 19 (New) (8 Marks), Practice Manual
Answer:
(i) Current Market Price of Bond:
Time CF PVIF 8% PV (CF) PV (CF)
1 14 0.926 12.964
2 14 0.857 11.998
129
3 14 0.794 11.116
4 14 0.735 10.290
5 114 0.681 77.634
∑PV (CF) i.e. P0 = 124.002
Say ₹124.00
(i) Minimum Market Price of Equity Shares at which Bondholder should exercise
124.00
conversion option: = = 6.20
20.00
(ii) Duration of Bond

Proportion of Proportion of bond
Year Cash flow P.V. @ 8%
1 14 0.926 12.964 0.105 0.105
2 14 0.857 11.998 0.097 0.194
3 14 0.794 11.116 0.089 0.267
4 14 0.735 10.290 0.083 0.332
5 114 0.681 77.634 0.626 3.130
124.002 1.000 4.028
Question 102
A hypothetical company ABC Ltd. issued a 10% Debenture (Face Value of ₹1000) of the duration
of 10 years is currently trading at ₹850 per debentures. The bond is convertible into 50 equity
shares being currently quoted at ₹17 per share.
If yield on equivalent comparable bond is 11.80%, then calculate the spread of yield of the above
bond from this comparable bond.
The relevant present value table is as follows.
Present Values t1 t2 t3 t4 t5 t6 t7 t8 t9 t10
PVIF0.11, t 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352
PVIF0.13 t 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376 0.333 0.295
RTP Nov 19 (Old), MTP Apr 19 (New) (7 Marks), MTP March 18 (New) (5 Marks), MTP Apr 19 (Old) (8
Marks), MTP March 19 (New) (7 Marks)
Answer:
Conversion Price = ₹50 × 17 = ₹850
Intrinsic Value = ₹850
130
Accordingly, the yield (r) on the bond shall be:

₹850 = ₹100 PVAF (r, 10) + ₹1000 PVF (r, 10)
Let us discount the cash flows by 11%

850 = 100 PVAF (11%, 10) + 1000 PVF (11%, 10)
850 = 100 × 5.890 + 1000 × 0.352 = 91
Now let us discount the cash flows by 13%
850 = 100 PVAF (13%, 10) + 1000 PVF (13%, 10)
850 = 100 × 5.426 + 1000 × 0.295 = -12.40
Accordingly, IRR
91
11%+ × (13%-11%)
91-(-12.40)
91
= 11%+ × ሺ13%-11%ሻ
103.40
= 12.76%
The spread from comparable bond = 12.76% - 11.80% = 0.96%
Question 103
TN Ltd. has ₹600 Lakh 10% bonds outstanding with 5 years remaining to maturity. Since interest
rate is falling, TN Ltd. is planning of refunding these bonds with a ₹600 Lakh issue of 5 years
bonds carrying a coupon rate of 7%. Issue cost of new bond will be ₹12 Lakh and call premium
is 3%. ₹18 Lakh being the unamortised portion of issue cost of old bonds can be written off. Tax
Rate applicable to TN Ltd. is 30%.
You are required to analyse Bond Refunding Decision.
PVF 7% and 4.9% for five years are as under:
Rate 1 Year 2 Year 3 Year 4 Year 5 Year Total
7% 0.935 0.873 0.816 0.763 0.713 4.100
4.90% 0.953 0.909 0.866 0.826 0.787 4.341
Dec 21 (New) (8 Marks), May 13 (6 Marks)
Answer:
1. Calculation of initial outlay:-
(a) Cost of Calling Old Bond
₹ (in Lakhs)
Face value 600
Add: Call premium 18
Cost of calling old bonds 618
131
(b) Net Proceeds from New Issue

₹ (in Lakhs)
Gross proceed of new issue 600
Less: Issue costs 12
Net Proceed from New Issue 588
(c) Tax savings on call premium and unamortized cost = 0.30 (18 + 18) = 10.80
Initial outlay = ₹618 Lakh - ₹588 Lakh - ₹10.80 Lakh
= ₹19.20 Lakh
2. Calculation of net present value of refunding the bond:-

₹ (in Lakhs)
Saving in annual interest expenses [600 × (0.10 – 0.07)] 18.00
Less: Tax saving on interest and amortization
5.76
(0.30 × [18 + (18-12)/5])
Annual net cash saving 12.24
PVIFA (4.96%, 5 years) 4.341
Present value of net annual cash saving 53.13
Less: Initial outlay 19.20
Net present value of refunding the bond 33.93
Decision: The bonds should be refunded.
Question 104
Tangent Ltd. is considering calling ₹3crores of 30 years, ₹1,000 bond issued 5 years ago with a
coupon interest rate of 14 per cent. The bonds have a call price of ₹1,150 and had initially
collected proceeds of ₹2.91crores since a discount of ₹30 per bond was offered. The initial
floating cost was ₹3,90,000. The Company intends to sell ₹3crores of 12 per cent coupon rate,
25 years bonds to raise funds for retiring the old bonds. It proposes to sell the new bonds at their
par value of ₹1,000. The estimated floatation cost is ₹4,25,000. The company is paying 40% tax
and its after tax cost of debt is 8 per cent. As the new bonds must first be sold and then their
proceeds to be used to retire the old bonds, the company expects a two months period of
overlapping interest during which interest must be paid on both the old and the new bonds. You
are required to evaluate the bond retiring decision. [PVIFA 8%, 25 = 10.675]
Answer:
132
NPV for bond refunding

₹
PV of annual cash flow savings (W.N. 2)
(3,49,600 x PVIFA 8 %, 25) i.e. 10.675 37,31,980
Less: Initial investment (W.N. 1) 31,15,000
NPV 6,16,980
Recommendation: Refunding of bonds is recommended as NPV is positive.

Working Notes:
(i) Initial Investment:
(a) Call Premium
Before tax (1,150 - 1,000) × 30,000 45,00,000
Less Tax @ 40% 18,00,000
After tax cost of call premium 27,00,000
(b) Floatation Cost 4,25,000
(c) Overlapping Interest
Before tax (0.14 × 2/12 × 3 Crores) 7,00,000
Less tax @ 40% 2,80,000 4,20,000
(d) Tax saving on unamortized discount on old (3,00,000)
bond (25/30 × 9,00,000 × 0.4)
(e) Tax savings from unamortized floatation cost (1,30,000)
of old bonds (25/30 × 3,90,000 × 0.40)
31,15,000
(ii) Annual cash flow savings:

a. Old Bond
(i) Interest cost (0.14 × 3 crores) 42,00,000
Less tax @ 40% 16,80,000 25,20,000
(ii) Tax savings from amortisation of discount (12,000)
(9,00,000/30 × 0.4)
(iii) Tax savings from amortization of floatation (5,200)
cost (3,90,000/30 )
Annual after tax cost payment under old Bond (A) 25,02,800
133
b. New bond
(i) Interest Cost (0.12 × 3 crores) 36,00,000
Less Tax @ 40% 14,40,000 21,60,000
(ii) Tax savings from amortisation of (6,800)
floatation cost 0.4 × 4,25,000/25
Annual after tax payment under new Bond (B) 21,53,200
Annual Cash Flow Saving (A) – (B) 3,49,600
Question 105
ABC Ltd. has ₹300 million, 12 per cent bonds outstanding with six years remaining to maturity.
Since interest rates are falling, ABC Ltd. is contemplating of refunding these bonds with a
₹300 million issue of 6 years bonds carrying a coupon rate of 10 per cent. Issue cost of the
new bond will be ₹6 million and the call premium is 4 per cent. ₹9 million being the unamortized
portion of issue cost of old bonds can be written off no sooner the old bonds are called off.
Marginal tax rate of ABC Ltd. is 30 per cent. You are required to analyse the bond refunding
decision.
June 09 (6 Marks), RTP Nov 11, RTP May 14, MTP Mar 18 (Old) (8 Marks) RTP May 20
(Old), Practice Manual, StudyMat
Answer:
a. Calculation of initial outlay ₹(million)
Face value 300
Add: Call premium 12
Cost of calling old bonds 312
Gross proceed of new issue 300
Less: Issue costs 6
Net proceeds of new issue 294
Tax savings on call premium and unamortized cost 0.30 (12 + 9) 6.3
Initial outlay = ₹312 million–₹294 million–₹6.3 million = ₹11.7 million
134
b. Calculation of net present value of refunding the bond:-
Saving in annual interest expenses ₹(million)

[300 × (0.12 – 0.10)] 6.00
Less:- Tax saving on interest and amortization
0.30 × [6 + (9 - 6)/6] 1.95
Annual net cash saving 4.05
PVIFA (7%, 6 years) 4.766
∴Present value of net annual cash saving 19.30
Less:- Initial outlay 11.70
Net present value of refunding the bond 7.60
Decision: The bonds should be refunded
Question 106
M/s Transindia Ltd. is contemplating calling ₹3 crores of 30 years, ₹1,000 bond issued 5 years
ago with a coupon interest rate of 14 per cent. The bonds have a call price of ₹1,140 and had
initially collected proceeds of ₹2.91 crores due to a discount of ₹30 per bond. The initial floating
cost was ₹3,60,000. The Company intends to sell ₹3 crores of 12 per cent coupon rate, 25
years bonds to raise funds for retiring the old bonds. It proposes to sell the new bonds at their
par value of ₹1,000. The estimated floatation cost is ₹4,00,000. The company is paying 40%
tax and its after tax cost of debt is 8 per cent. As the new bonds must first be sold and their
proceeds, then used to retire old bonds, the company expects a two months period of
overlapping interest during which interest must be paid on both the old and new bonds. What
is the feasibility of refunding bonds?
Dec 21 (Old) (12 Marks), MTP Nov 21 (New) 10 Marks, RTP Nov 14, RTP Nov 16, Practice Manual
Answer:
NPV for bond refunding
₹
PV of annual cash flow savings (W.N. 2)
(3,49,600 × PVIFA 8%,25) i.e. 10.675 37,31,980
Less: Initial investment (W.N. 1) 29,20,000
NPV 8,11,980
Recommendation: Refunding of bonds is recommended as NPV is positive.
135
Working Notes:
(1) Initial investment

(a) Call premium
Before tax (1,140 – 1,000) × 30,000 42,00,000
Less: tax @ 40% 16,80,000
After tax cost of call prem. 25,20,000
(b) Floatation cost 4,00,000
(c) Overlapping interest
Before tax (0.14 × 2/12 × 3 crores) 7,00,000
Less: tax @ 40% 2,80,000
After tax cost of Overlapping interest 4,20,000
(d)Tax saving on unamortized discount on old (3,00,000)
bond 25/30 × 9,00,000 × 0.4
(e) Tax savings from unamortized floatation (1,20,000)
Cost of old bond 25/10 × 3,60,000 × 0.4
29,20,000
(2) Annual Cash Flow Savings:

(a) Old bond
Interest cost (0.14 × 3 crore) 42,00,000
Less Tax @ 40% 16,80,000 25,20,000
Tax savings from amortization of discount (12,000)
9,00,000/30 × 0.4
Tax savings from amortization of floatation cost (4,800)
3,60,000/30 × 0.4
Annual after tax payment under old bond (A) 25,03,200
(b) New bond

Interest cost before tax (0.12 × 3 crore) 36,00,000
Less Tax @ 40% 14,40,000 21,60,000
Tax savings from amortization of floatation cost
(0.4 × 4,00,000/25) (6,400)
Annual after tax payment under new bond (B) 21,53,600
Annual cash flow savings [(A) - (B)] 3,49,600
136
Question 107
MP Ltd. issued a new series of bonds on January 1, 2010. The bonds were sold at par (₹1,000),
having a coupon rate 10% p.a. and mature on 31st December, 2025. Coupon payments are
made semiannually on June 30th and December 31st each year. Assume that you purchased
an outstanding MP Ltd. bond on 1st March, 2018 when the going interest rate was 12%.
Required:
(i) What was the YTM of MP Ltd. bonds as on January 1, 2010?
(ii) What amount you should pay to complete the transaction? Of that amount how much should
be accrued interest and how much would represent bonds basic value.
Practice Manual
Answer:
(i) Since the bonds were sold at par, the original YTM was 10%.
Interest ₹100
YTM = = = 10%
Principal ₹1,000
(ii) Price of the bond as on 1st July, 2018 = ₹50 × 9.712 + ₹1,000 × 0.417
= ₹485.60 + ₹417
= ₹902.60
Total value of the bond on the next = ₹902.60 + ₹50

interest date 30/06/18 = ₹952.60
1
Value of bond at purchase date = ₹952.60 × 2/3
(1+0.06)
= ₹952.60 × 0.9620 (by using excel)
= ₹916.40†
The amount to be paid to complete the transaction is ₹916.40. Out of this amount
₹48.10 represent accrued interest* and ₹868.30 represent the bond basic value.
† Alternatively, it can also be calculated as follows:

1
= ₹952.60 ×
2
(1+0.06 × )
3
1
= ₹952.60 ×
ሺ1+0.04ሻ
= ₹915.96
137
The amount to be paid to complete the transaction is ₹915.96. Out of this amount
₹48.08 represent accrued interest* and ₹867.88 represent the bond basic value.
*Alternatively, Accrued Interest can also be calculated as follows:

10 2
Accrued Interest on Bonds = 1,000 × = 16.67
100 12
Question 108
Capital structure of Sun Ltd., as at 31.3.2003 was as under:
(₹in lakhs)
Equity share capital 80
8% Preference share capital 40
12% Debentures 64
Reserves 32
Sun Ltd., earns a profit of ₹32 lakhs annually on an average before deduction of income tax,
which works out to 35%, and interest on debentures. Sun Ltd. has been regularly paying equity
dividend of 8%
Normal return on equity shares of companies similarly placed is 9.6% provided:
(i) Profit after tax covers fixed interest and fixed dividends at least 3 times.
(ii) Capital gearing ratio is 0.75.
(iii) Yield on share is calculated at 50% of profits distributed and at 5% on undistributed profits.
Analyse the value per equity share of the company assuming the risk free premium as:
(A) 1% for every one time of difference for Interest and Fixed Dividend Coverage.
(B) 2% for every one time of difference for Capital Gearing Ratio.
RTP May 17, MTP Oct 18 (New) (10 Marks), Practice Manual, StudyMat
Answer:
(i) Calculation of Profit after tax (PAT)
₹
Profit before interest and tax (PBIT) 32,00,000
Less: Debenture interest (₹64,00,000 × 12/100) 7,68,000
Profit before tax (PBT) 24,32,000
Less: Tax @ 35% 8,51,200
Profit after tax (PAT) 15,80,800
138
Less: Preference Dividend

(₹40,00,000 × 8/100) 3,20,000
Equity Dividend (₹80,00,000 × 8/100) 6,40,000 9,60,000
Retained earnings (Undistributed profit) 6,20,800
Calculation of Interest and Fixed Dividend Coverage

PAT + Debenture interest
=
Debenture interest + Preference dividend
15,80,800+7,68,000
=
7,68,000+3,20,000
23,48,800
=
10,88,000
= 2.16 times
(ii) Calculation of Capital Gearing Ratio

Fixed interest bearing funds
Capital Gearing Ratio =
Equity shareholders' funds
Preference Share Capital + Debentures
=
Equity Share Capital + Reserves
40,00,000+64,00,000
=
80,00,000+32,00,000
10400000
=
11200000
= 0.93
(iii) Calculation of Yield on Equity Shares:

Yield on equity shares is calculated at 50% of profits distributed and 5% on undistributed
profits:
₹
50% on distributed profits (₹6,40,000 × 50/100) 3,20,000
5% on undistributed profits (₹6,20,800 × 5/100) 31,040
Yield on equity shares 3,51,040
Yield on shares 3,51,040

Yield on equity shares % = × 100 = × 100 = 4.39% or,4.388%
Equity share capital 80,00,000
139
Calculation of Expected Yield on Equity shares

(A) Interest and fixed dividend coverage of Sun Ltd. is 2.16 times but the industry average
is 3 times. Therefore, risk premium is added to Sun Ltd. Shares @ 1% for every 1 time
of difference. Hence,
Risk Premium = 3.00 – 2.16 (1%) = 0.84 (1%) = 0.84%
(B) Capital gearing ratio of Sun Ltd. is 0.93 but the industry average is 0.75 times.
Therefore, risk premium is added to Sun Ltd. shares @ 2% for every 1 time of
difference. Hence
Risk Premium = (0.75 – 0.93) (2%) = 0.18 (2%) = 0.36%
(%)
Normal return expected 9.60
Add: Risk premium for low interest and fixed dividend coverage 0.84
Add: Risk premium for high interest gearing ratio 0.36
10.80
Actual Yield 4.39

Value of Equity Share = × Paid-up value of share = × 100 = ₹40.65
Expected Yield 10.80
Question 109
The HLL has ₹8.00 crore of 10% mortgage bonds outstanding under an indenture. The
indenture allows additional bonds to be issued as long as all of the following conditions are
met:
Income before tax + Bond Interest
1. Pre-Tax interest coverage( ) remains greater than 4.
Bond Interest
2. Net depreciated value of mortgage assets remains twice the amount of the mortgage
debt.
3. Debt-to-equity ratio remains below 0.50.
The HLL has net income after taxes of ₹2 crores and a 40% tax-rate, ₹ 40 crores in equity and
₹30 crores in depreciated assets, covered by the mortgage.
Assuming that 50% of the proceeds of a new issue would be added to the base of mortgaged
assets and that the company has no Sinking Fund payments until next year, how much more
10% debt could be sold under each of the three conditions? Which protective covenant is
binding?
MTP Oct 17 (8 Marks)
Answer:
Let x be the crores of Rupees of new 10% debt which would be sold under each of the three
given conditions. Now, the value of x under each of the three conditions is as follows:
140
Income before tax + Bond Interest

1. Pre-Tax interest coverage( ) remains greater than 4.
Bond Interest
₹2crores/(1-0.4)+8crores × 0.1+x × 0.1
=4
(8crores × 0.1)+(x × 0.1)
₹3.33crores+0.8crores+0.10x
=4
(0.80crores+₹0.10x)
₹4.13crores+0.10x
=4
(0.80crores+₹0.10x)
₹4.13 crores + 0.10x = 4 (₹0.80 crores + ₹0.10x)
₹4.13 crores + 0.10x = ₹3.2 crores + ₹0.40x
₹0.30x = 0.93
x = ₹0.93/0.30
x = ₹3.10 crores
Additional mortgage required shall be a maximum of ₹3.10 crores.
2. Net depreciated value of mortgage assets remains twice the amount of

mortgage debt
(Assuming that 50% of the proceeds of new issue would be added to the base of
mortgaged assets)
₹30crores +0.5x
i.e. =2
₹8crores+x
or ₹30 crores + 0.5x = 2 (₹8 crores + x)
or ₹1.5x = ₹14 crores
₹14crores
or =
1.5
or x = 9.33crores
Additional mortgage required to satisfy condition No. 2 is ₹9.33 crores
3. Debt to equity ratio remains below 5

₹8crores+x
i.e. = 0.50
₹40crores
₹8 crores + x = ₹20 crores
x = ₹12 crores
Since all the conditions are to be met, then ₹3.10 crores (as per condition – 1) can be
borrowed by issuing additional bonds.
Thus, binding conditions are met and it limits the amount of new debt to 3.10 crore.
141
Question 110
Tiger Ltd. is presently working with an Earnings Before Interest and Taxes (EBIT) of ₹90 lakhs.
Its present borrowings are as follows:
₹In lakhs
12% term loan 300
Working capital borrowings:
From Bank at 15% 200
Public Deposit at 11% 100
The sales of the company are growing and to support this, the company proposes to obtain
additional borrowing of ₹100 lakhs expected to cost 16%. The increase in EBIT is expected to
be 15%. Calculate the change in interest coverage ratio after the additional borrowing is effected
and comment on the arrangement made.
Answer:
Calculation of Present Interest Coverage Ratio
Present EBIT = ₹90 lakhs
Interest charges (Present) ₹lakhs
Term loan @ 12% 36.00
Bank Borrowings @ 15% 30.00
Public Deposit @ 11% 11.00
77.00
EBIT ₹90 lakhs

Present Interest Coverage Ratio = = = 1.169
Interest Charges ₹77 lakhs
Calculation of Revised Interest Coverage Ratio

Revised EBIT (115% of ₹90 lakhs) ₹103.50 lakhs
Proposed interest charges
Existing charges ₹77.00 lakhs
Add: Additional charges (16% of additional Borrowings i.e.
₹100 lakhs) ₹16.00 lakhs
Total ₹93.00 lakhs
₹103.50 lakhs
Revised Interest Coverage Ratio = = 1.113
₹93.00 lakhs
142
Analysis: With the proposed increase in the sales the burden of interest on additional
borrowings of ₹100 lakhs will adversely affect the interest coverage ratio which has been
reduced. (i.e. from 1.169 to 1.113).
Question 111
RBI sold a 91-day T-bill of face value of ₹100 at an yield of 6%. What was the issue price?
MTP Feb 14 (5 Marks), StudyMat
Answer:
Let the issue price be X
By the terms of the issue of the T-bills:
100-x 365
6% = × × 100
x 91
6 × 91 × x
= (100-x)
36,500
0.01496 x = 100 – x
100
x= = ₹98.53
1.01496
Question 112
Suppose Mr. X purchase Treasury Bill for ₹9,940 maturing in 91 days for ₹10,000. Then what
would be annualized investment rate for Mr. X and annualized discount rate for the Govt.
Investment. RTP Nov 11
Answer:
₹10,000-₹9,940 365
Investment Rate = × = 0.02421 i.e. 2.42%
₹9,940 91
₹10,000-₹9,940 360
Discount Rate = × = 0.02374 i.e. 2.374%
₹10,000 91
Question 113
Suppose Govt. pays ₹5,000 at maturity for 91 days Treasury Bill. If Mr. Y is desirous to earn an
annualized discount rate of 3.5%, then how he can pay for it.
RTP Nov 11
Answer:
Suppose X be the maximum amount Mr. Y can pay for Treasury Bill. Then,
₹5,000-X 360
× = 0.035
₹5,000 91
₹5,000 - X = ₹44.24
X = ₹4,955.76
143
Question 114
Wonderland Limited has excess cash of ₹20 lakhs, which it wants to invest in short term
marketable securities. Expenses relating to investment will be ₹50,000.
The securities invested will have an annual yield of 9%.
The company seeks your advice
(i) as to the period of investment so as to earn a pre-tax income of 5%. (discuss)
(ii) the minimum period for the company to breakeven its investment expenditure overtime
value of money.
Nov 14 (5 Marks), MTP Feb 16 (8 Marks), MTP Aug 18 (Old) (5 Marks),
MTP May 20 (Old) (4 Marks), RTP Nov 17, StudyMat
Answer:
(i) Pre-tax Income required on investment of ₹20,00,000
Let the period of Investment be ‘P’ and return required on investment ₹1,00,000
(₹20,00,000 × 5%)
Accordingly,
9 P
(₹20,00,000 × × ) -₹50,000 = ₹1,00,000
100 12
P = 10 months
(ii) Break-Even its investment expenditure

9 P
(₹20,00,000 × × ) -₹50,000 = 0
100 12
P = 3.33 months
Question 115
Sea Rock Ltd. has an excess cash of ₹30,00,000 which it wants to invest in short-term
marketable securities.
(i) Expenses resulting to investment will be ₹45,000. The securities invested will have an
annual yield of 10%. The company seeks your advice as to the period of investment so
as to earn a pre-tax income of 6%.
(ii) Also find the minimum period for the company to break-even its investment expenditure.
Ignore time value of money
Nov 17 (6 Marks)
Answer:
(i) Pre-tax Income required on investment of ₹30,00,000 is ₹1,80,000.
Let the period of Investment be ‘P’ and return required on investment ₹1,80,000
(₹30,00,000 × 6%)
144
Accordingly,
10 P
= (₹30,00,000 × × ) - ₹45,000 = ₹1,80,000
100 12
P = 9 months
(ii) Break-Even its investment expenditure

10 P
= (₹30,00,000 × × ) - ₹45,000 = 0
100 12
P = 1.80 months
Question 116
Z Co. Ltd. issued commercial paper worth ₹10 crores as per following details:
Date of issue : 16th January, 2019
Date of maturity: 17th April, 2019
No. of days : 91
Interest rate 12.04% p.a
What was the net amount received by the company on issue of CP? (Charges of intermediary
may be ignored)
MTP Nov 21 (New) 6 Marks, MTP Nov 21 (Old) (5 Marks), MTP Oct 14 (5 Marks), StudyMat
Answer:
The company had issued commercial paper worth ₹10 crores
No. of days Involves = 91 days
Interest rate applicable = 12.04 % p.a.
91 Days
Interest for 91 days = 12.04% × = 3.002%
365 Days
3.002
= or ₹10 crores ×
100+3.002
= ₹29,14,507 or ₹29.14507 Lakhs
∴ Net amount received at the time of issue
= ₹10.00 Crores – ₹0.29151 Crores
= ₹9.70849 Crores
Alternatively, it can also be computed as follows:

₹10 crores
Price = = ₹9.70855 crores
91 Days
(1+12.04% × )
365 Days
145
Question 117
From the following particulars, calculate the effective rate of interest p.a. as well as the total cost
of funds to Bhaskar Ltd., which is planning a CP issue:
Issue Price of CP ₹97,550
Face Value ₹1,00,000
Maturity Period 3 Months
Issue Expenses:
Brokerage 0.15% for 3 months
Rating Charges 0.50% p.a.
Stamp Duty 0.175% for 3 months
Nov 10 (5 Marks), MTP April 14 (8 Marks), MTP Oct 20 (Old) (4 Marks), RTP May 18
Answer:
F-P 12
Nominal Interest or Bond Equivalent Yield = ൤ ൨× × 100
P M
Where
F = Face Value
P = Issue Price
1,00,000-97,550 12
= × × 100 = 0.025115 × 4 × 100 = 10.046 = 10.05% p.a.
97,550 3
0.1005 4
Effective interest rate = ൤1+ ൨ -1 = 10.435% p.a.
4
Cost of Funds to the Company

Effective Interest 10.435%
Brokerage (0.150 × 4) 0.60%
Rating Charge 0.50%
Stamp duty (0.175 × 4) 0.70%

12.235%
Alternatively, effective interest rate can also be computed as follows:

Let i be the interest rate then
100000
97,750 =
3
1+i ×
12
i = 10.046
146

Brokerage (0.150 × 4) 0.60%
Rating Charge 0.50%
Stamp duty (0.175 × 4) 0.70%
11.846%
Question 118
From the following information, compute the effective rate of interest per annum as well as the
total cost of funds to Nirmal Ltd., which is planning a Commercial Paper (CP) issue:
Issue Price of CP ₹4,87,750
Face Value ₹5,00,000
Maturity Period 3 Months
Issue Expenses:
Brokerage 0.15% for 3 months
Rating Charges 0.55% p.a.
Stamp Duty 0.20% for 3 months
Answer:
F-P 12
Nominal Interest or Bond Equivalent Yield = ൤ ൨× × 100
P M
Where, F = Face Value, P = Issue Price
5,00,000-4,87,750 12
= × × 100 = 0.025115 × 4 × 100 = 10.046 = 10.05% p.a.
4,87,750 3
0.1005 4
Effective interest rate = ൤1+ ൨ -1 = 10.435% p.a.
4

Brokerage (0.150 × 4) 0.60%
Rating Charge 0.55%
Stamp duty (0.20 × 4) 0.80%
12.385%
147
Question 119
AXY Ltd. is able to issue commercial paper of ₹50,00,000 every 4 months at a rate of 12.5%
p.a. The cost of placement of commercial paper issue is ₹2,500 per issue. AXY Ltd. is required
to maintain line of credit ₹1,50,000 in bank balance. The applicable income tax rate for AXY Ltd.
is 30%. What is the cost of funds (after taxes) to AXY Ltd. for commercial paper issue?
The maturity of commercial paper is four months.
May 14 (5 Marks), RTP Nov 15, MTP Oct 15 (5 Marks), MTP Oct 19 (Old) (5 Marks), Practice Manual
Answer:
₹
Issue Price 50,00,000
Less: Interest @ 12.5% for 4 months 2,08,333
Issue Expenses 2,500
Minimum Balance 1,50,000
46,39,167
2,10,833(1-0.30) 12
Cost of Funds = × × 100 = 9.54%
46,39,167 4
Alternatively
₹
46,39,167
Opportunity Cost @ 12.5% of ₹1,50,000 for 4 months 6,250
2,10,833(1-0.30)+6,250 12
Cost of Funds = × × 100 = 9.95%
46,39,167 4
Alternatively
Since Commercial Paper is a discount instrument it can also be presumed same shall be
issued at discounted price. Accordingly, answer shall be as follows:
50,00,000
Issue Price = = ₹48,00,000
4
1+12.5 ×
12
148
₹
44,47,500
Opportunity Cost @ 12.5% of ₹1,50,000 for 4 months 6,250
2,02,500ሺ1-0.30ሻ 12
Cost of Funds = × × 100 = 9.56%
44,47,500 4
OR
2,02,500ሺ1-0.30ሻ+6,250 12
Cost of Funds = × × 100 = 9.98%
44,47,500 4
Question 120
LMN & Co. plans to issue Commercial Paper (CP) of ₹1,00,000 at a price of ₹98,000.
Maturity Period : 4 Months
Expenses for issue of CP are :
(i) Brokerage : 0.10%
(ii) Rating Charges : 0.60% and
(iii) Stamp Duty : 0.15%
Find the effective interest rate per annum and the cost of Fund.
May 12 (5 Marks)
Answer:
F-P 12
Effective Interest Rate = ൤ ൨× × 100
P m
1,00,000-98,000 12
= × × 100
98,000 4
= 0.02041 × 3 × 100
= 6.123% say 6.12%
Effective Interest Rate = 6.12% p.a.
149

Brokerage 0.10%
Rating Charges 0.60%
Stamp Duty 0.15%
Cost of funds 6.97%
Note: In the question it has not been clearly mentioned whether issue expenses pertain to
a year or 4 months. Although above solution is based on the assumption that these
expenses pertains to a year, but students can also consider them as expenses for 4 months
and solve the question accordingly.
Question 121
RC Ltd. is able to issue commercial paper of ₹50,00,000 every 4 months at a rate of 15% p.a.
The cost of placement of commercial paper issue is ₹2,000 per issue. RC Ltd. is required to
maintain line of credit ₹2,00,000 in bank balance. The applicable income tax rate for RC Ltd. is
30%. What is the cost of funds (after taxes) to RC Ltd. for commercial paper issue? The maturity
of commercial paper is four months.
May 17 (4 Marks)
Answer:
₹
Less: Interest @ 15% for 4 months 2,50,000
45,48,000
2,52,000(1-0.30) 12 5 ,29,200
Cost of Funds = × × 100 = × 100 = 11.636%
45,48,000 4 45,48,000
150
Question 122
Two companies XYZ Ltd. and ABC Ltd., each issues Commercial Paper (CP) of ₹5 million each
maturing in 91 days. While XYZ’s CP has credit rating of A1 the ABC’s CP has A3 from CRISIL.
XYZ and ABC CPs are issued at 7.6% and 8.5% respectively.
You are required to determine the compensation for ABC’s CP for greater credit risk. Assume
number of days a year is 365.
MTP March 18 (Old) (5 Marks)
Answer:
XYZ Ltd. will sell CP at the following price:
₹50,00,000 ₹50,00,000
= = ₹49,07,022
91 ሾሺ1+ 0.018948ሻሿ
൤(1+0.076 × )൨
365
ABC Ltd. will sell CP at the following price:

₹50,00,000 ₹50,00,000
= = ₹48,96,239
91 ሾሺ1+ 0.021192ሻሿ
൤(1+0.085 × )൨
365
Accordingly, compensation for higher Credit Risk shall be:

₹49,07,022 - ₹48,96,239 = ₹10,783
Question 123
Consider the following for Certificate of Deposit (CD):
Amount of Issue – ₹100
Period - 6 months
Rate of discount – 20%
Calculate the effective yield.
StudyMat
Answer:
20 6
Discount = 100 × × = ₹10.00
100 12
Hence CD will be issued for ₹100 – 10 = ₹90.00.
The effective rate to the bank will, however, be calculated on the basis of the following
formula:
FV-SV Days or months in a year
E= × × 100
SV M
Where, E = Effective Yield, FV = Face Value, SV = Sale Value, M = Period of Discount
Accordingly, the Yield as per the data given in the example will be:
100-90 12
× × 100 = 22.22%
90 6
151
Question 124
M Ltd. has to make a payment on 30th January, 2010 of ₹80 lakhs. It has surplus cash today,
i.e. 31st October, 2009; and has decided to invest sufficient cash in a bank's Certificate of
Deposit scheme offering an yield of 8% p.a. on simple interest basis. What is the amount to be
invested now?
RTP Nov 11, RTP May 14, RTP Nov 14, RTP Nov 18 (Old), MTP Sept 14 (5 Marks), MTP April 18 (Old) (5
Marks), Practice Manual
Answer:
Calculation of Investment Amount
Amount required for making payment on 30th January, 2010 = ₹80,00,000
Investment in Certificates of Deposit (CDs) on 31st October, 2009
Rate of interest = 8% p.a.
No. of days to maturity 91 days
Interest on ₹1 of 91 days (₹1 × 0.08 × 91/365) = 0.0199452
Amount to be received for Re. 1 (₹1.00 + ₹0.0199452) = 1.0199452
Calculation of amount to be invested now to get ₹80 lakhs after 91 days:

₹80,00,000
= = ₹78,43,558.65
₹1.0199452
Or, ₹78,43,600 or ₹78,44,000 approximately
Question 125
A bond is held for a period of 45 days. The current discount yield is 6 per cent per annum. It is
expected that current yield will increase by 200 basis points and current market price will come
down by ₹2.50.
Calculate:
(i) Face value of the Bond and
(ii) Bond Equivalent Yield
May 18 (Old) (4 Marks)
Answer:
(i) Face Value of the Bond
(a) Current Market Price* 45 days 6 0.9925
(b) Current Market Price* 45 days 8 0.9900
(c) Difference in Price Per Unit (a) – (b) 0.0025
(d) Difference in Price ₹ 2.50
152
(e) Face Value of Bond (d)/ (c) ₹ 1,000

(f) Current Market Price (a) × (e) 6 ₹ 992.50
(g) Current Market Price (b) × (e) 8 ₹990.00
* 1 – [(Discount Rate/ 100) × (45/360)]

At the rate of 6% 1,000 - 992.50 360 6.05
× × 100 †
992.50 45
At the rate of 8% 1,000 - 990.00 360 8.08
× × 100 †
990.00 45
Alternative Solution if 365 days a year are assumed

(i) Face Value of the Bond
%
(a) Current Market Price* 45 days 6 0.9926
(b) Current Market Price* 45 days 8 0.9901
(c) Difference in Price Per Unit (a) – (b) 0.0025
(d) Difference in Price ₹2.50
(e) Face Value of Bond (d)/ (c) ₹1,000
(f) Current Market Price (a) × (e) 6 ₹992.60
(g) Current Market Price (b) × (e) 8 ₹990.10
* 1 – [(Discount Rate/ 100) × (45/365)]

At the rate of 6% 1,000 - 992.60 365 6.05
× × 100 †
992.60 45
At the rate of 8% 1,000 - 990.10 365 8.11
× × 100 †
990.10 45
FV-CV 365
† × × 100
CV 45
153
Question 126
A money market instrument with face value of ₹100 and discount yield of 6% will mature in 45
days. You are required to calculate:
(i) Current price of the instrument.
(ii) Bond equivalent yield
(iii) Effective annual return.
MTP March 15 (6 Marks), Practice Manual
Answer:
(i) Current price of the Bond = 100 x [1-{45/360} x 0.06] = ₹99.25
Alternatively, the current price of bond may also be calculated as follows:
D 360
× = 0.06
100-D 45
D 45
= 0.06 ×
100-D 360
D 1
= 0.06 ×
100-D 8
8D = 6-0.06D
8.06D = 6
6
D= = 0.7444
8.06
Current price of the bond = Face value – D

= ₹100 – 0.7444
= ₹99.2556
(ii)
100-99.25 360
Bond equivalent yield = × = 6.045% p.a.
99.25 45
(iii)
Effective annual return = [1 + (0.06045/8)]8 – 1 = 6.207% p.a.
Note: If a year of 365 days is considered the Bond equivalent yield and Effective annual
return works out to 6.296% p.a.
154
Question 127
On 30th June 2015, PNB Bank proposes to borrow a sum of ₹400 crore from CB Bank via Repo
@ 11.65% using 10.00% GOI Securities 2025 (face value ₹10,000) for a period of 14 days with
a 3.00% haircut.
The current price of the securities is ₹9,872. The coupon dates are 30 April and 30 September.
(i) Nominal Amount as well as No. of Securities to be delivered in the beginning of the Repo.
(ii) The cash amount to be repaid at the end of the Repo.
MTP April 19 (Old) (5 Marks)
Answer:
(i) The GOI Security has semi-annual coupon of 30 April hence the accrual period is 1 May
2015 to 30 June 2015 i.e. 61 days. Therefore,
10 61
Accrued Interest on Security = 10000 × × = ₹167.12
100 365
Dirty Price = ₹ 9,872 + ₹167.12 = ₹10,039.12
10039.12
Dirty Price Adjusted for 3% haircut = = ₹9,746.72
1.03
10000
Nominal Amount of Securities Required = 400 × = ₹410.39447 crore
9746.72
410.39 447
No. of securities required = = 4,21,059 (Approx.)
9746.72
(ii) The original cash amount to be repaid at the end

14
₹400 crore × (1+0.1165 × ) = ₹401.7874 crore
365
Question 128
On 30th June 2015 PNB Bank proposes to borrow a certain sum of money from CB Bank for a
period of 14 days @ 12% p.a. against 13.5% GOI Securities having a face value of ₹400 crore
currently trading at ₹410 crore maturing on 30th September 2015.
The coupon dates are 30 April and 30 September. You are required to determine the amount of
borrowing and buy-back price of securities.
MTP Sept 15 (5 Marks)
Answer:
PNB Bank sells 13.50% GOI Securities of face value of ₹400 crore at current market price of
₹410 crore.
Cash Outflow to CB Bank on 30.04.2015 (Amount of Borrowing)
155
Value of Security ₹410.00 crore

61 ₹9.15 crore
Interest for the period 30.4.15 to 29.6.15 ( × 0.135 × 400)
360
₹419.15 crore
Buyback Price of Securities

Amount of Loan ₹419.15 crore
14 ₹1.9560 crore
Add: Interest for 14 days @ 12% ( × 0.12 × 419.15)
360
₹421.106 crore
75 ₹11.250 crore
Less: Interest for the period 30.4.15 to 13.7.15 ( × 0.135 × 400)
360
₹409.856 crore
Question 129
Bank A enters into a Repo for 14 days with Bank B in 12% GOI Bonds 2017 at a rate of 5.25%
for Rs.5 Crore. Assuming that the clean price be 99.42, initial margin be 2% and days of accrued
interest be 292, you are required to determine:
(a) Dirty Price
(b) Start Proceeds (First Leg)
(c) Repayment at Maturity (Second Leg)
Note: Number of days in a year is 360.
RTP May 16, MTP Oct 17 (5 Marks)
Answer:
(i) Dirty Price
= Clean Price + Interest Accrued
12 292
= 99.42+100 × ×
100 360
= 109.1533
(ii) First Leg (Start Proceed)

Dirty Price 100-Initial Margin
= Nominal Value × ×
100 100
109.1533 100-2
= ₹5,00,00,000 × ×
100 100
= ₹5,34,85,117 say ₹5,34,85,000
156
(iii) Second Leg (Repayment at Maturity)

No. of days
= Start Proceed × (1+Repo rate × )
360
14
= ₹5,34,85,000 × (1+0.0525 × )
360
= ₹5,35,94,199
Question 130
Bank A enter into a Repo for 21 days with Bank B in 8% Government of India Bonds 2020 @
6.10% for ₹5 crore. Assuming that clean price is ₹97.30 and initial margin is 1.50% and days of
accrued interest are 240 days (assume 360 days in a year).
Compute:
(i) The dirty price.
(ii) The repayment at maturity.
Jan 21 (Old) (5 Marks), May 17 (4 Marks), MTP March 21 (Old) (5 Marks), StudyMat, Practice Manual
Answer:
(i) Dirty Price
= Clean Price + Interest Accrued
8 240
= 97.30+100 × × = 102.63
100 360
(ii) First Leg (Start Proceed)

= Nominal Value × ×
100 100
102.63 100-1.50
= ₹5,00,00,000 × × = ₹5,05,45,275
100 100
Second Leg (Repayment at Maturity)

No. of Days
= Start Proceed × (1+ Repo rate × ሻ
360
21
= ₹5,05,45,275 × (1+0.0610 × )
360
= ₹5,07,25,132
157
Question 131
The Bank BK enters into a Repo for 9 days with Bank NE in 6% Government bonds 2022 for
an amount of ₹2 crore. The other relevant details are as follows:
First Leg Payment (Start Proceed) ₹2,00,06,750
Second Leg Payment (Repayment Proceed) ₹2,00,31,759
Initial Margin 1.25%
Days of accrued interest 240
Assume 360 days in a year.

(i) Repo Rate
(ii) Dirty Price and
(iii) Clean Price July 21 (Old) (5 Marks)
Answer:
(i)
No. of Days
Second Leg = Start Proceed × (1 + Repo Rate × )
360
9
₹2,00,31,759 = ₹2,00,06,750 × (1+ Repo Rate × )
360
Repo Rate = 0.05 = 5%
(ii)
First Leg ሺStart Proceedሻ= Nominal Value × ×
100 100
Dirty Price 100-125
₹2,00,06,750 = ₹2,00,00,000× ×
100 100
10003.375 = 98.75 × Dirty Price

Dirty Price = ₹101.30
(iii) Dirty Price = Clean Price + Interest Accrued

240
101.30 = Clean Price + 100× × 6%
360
Clean Price = ₹97.30
158
CA Mayank Kothari 5. Portfolio Management
CHAPTER 5
PORTFOLIO MANAGEMENT
Question 1
A Stock costing ₹150 pays no dividends. The possible prices at which the stock may be sold for
at the end of the year with the respective probabilities are:
Price  (in ₹) Probability
130 0.2
150 0.1
160 0.1
165 0.3
175 0.1
180 0.2
Total 1.0

(i) Calculate the Expected Return,
(ii) Calculate the Standard Deviation (σ) of Returns.
Show calculations up to three decimal points.
May 17 (8 Marks), Practice Manual, StudyMat
Answer:
Here, the probable returns have to be calculated using the formula
D P1 -P0
R= +
P0 P0
Calculation of Probable Returns
Possible prices (P1) P1-P0 [(P1-P0)/ P0] × 100
₹ ₹ Return (per cent)
130 -20 -13.33
150 0 0.00
160 10 6.67
165 15 10.00
175 25 16.667
180 30 20.00
159
Calculation of Expected Returns

Possible return Probability Product
Xi p(Xi) X1-p(Xi)
-13.333 0.2 -2.667
0.00 0.1 0.000
6.667 0.1 0.667
10.00 0.3 3.000
16.667 0.1 1.667
20.00 0.2 4.000
X = 6.667
Expected return X = 6.667 per cent

Expected Price = 130 × 0.2 + 150 × 0.1 + 160 × 0.1 + 165 × 0.3 + 175 × 0.1 + 180 × 0.2
= 160
160-150
Return = × 100 = 6.667%
150
Calculation of Standard Deviation of Returns

Probable Probability Deviation Deviation Product
return Xi p(Xi) ¯ squared ¯ 2
(Xi -X) ¯ 2 (Xi -X) p(Xi )
(Xi -X)
-13.333 0.2 -20.00 400.00 80.00
0.00 0.1 -6.667 44.449 4.445
6.667 0.1 0 0 0
10.00 0.3 3.333 11.109 3.333
16.667 0.1 10.00 100.00 10.00
20.00 0.2 13.333 177.769 35.554
σ2 = 133.332
Variance, σ² = 133.332 per cent

Standard deviation, σ = ඥ133.332 = 11.547%
160
Question 2
Following information is available in respect of expected dividend, market price and market
condition after one year.
Market Probability Market Dividend
condition Price per share
₹ ₹
Good 0.25 115 9
Normal 0.50 107 5
Bad 0.25 97 3
The existing market price of an equity share is ₹106 (F.V. ₹1), which is cum 10% bonus
debenture of ₹6 each, per share. M/s. X Finance Company Ltd. had offered the buy-back of
debentures at face value.
Find out the expected return and variability of returns of the equity shares if buyback offer is
accepted by the investor.
And also advise-Whether to accept buy back offer?
Practice Manual
Answer:
The Expected Return of the equity share may be found as follows:
Market Probability Total Return Cost (*) Net
Condition Return
Good 0.25 ₹124 ₹100 ₹24
Normal 0.50 ₹112 ₹100 ₹12
Bad 0.25 ₹100 ₹100 ₹0
Expected Return = ሺ24 × 0.25ሻ+ሺ12 × 0.50ሻ+ሺ0 × 0.25ሻ = 12%

The variability of return can be calculated in terms of standard deviation.
V (SD) = 0.25 (24 – 12)2 + 0.50 (12 – 12)2 + 0.25 (0 – 12)2
=
0.25 (12)2 + 0.50 (0)2 + 0.25 (–12)2
=
36 + 0 + 36
SD = √72
SD = 8.485 or say 8.49%
(*) The present market price of the share is ₹106 cum bonus 10% debenture of ₹6 each;
hence the net cost is ₹100.
M/s X Finance company has offered the buyback of debenture at face value. There is
reasonable 10% rate of interest compared to expected return 12% from the market.
161
Considering the dividend rate and market price the creditworthiness of the company seems
to be very good. The decision regarding buy-back should be taken considering the maturity
period and opportunity in the market. Normally, if the maturity period is low say up to 1 year
better to wait otherwise to opt buy back option.
Question 3
The return of security ‘L’ and security ‘K’ for the past five years are given below:
Year Security-L Return% Security-K Return%
2012 10 11
2013 04 - 06
2014 05 13
2015 11 08
2016 15 14
Calculate the risk and return of portfolio consisting above information.

Nov 17 (10 Marks)
Answer:
If it is assumed 50% investment in each of the two securities then Return and Risk of Portfolio
shall be computed as follows:
Year Return Deviation Deviation Return Deviation Deviation Product of
of L ¯ ¯ 2 of K ¯ 2 deviations
¯
(RL -RL ) (RL -RL ) (Rk -Rk ) (Rk -Rk )
2012 10 1 1 11 3 9 3
2013 04 -5 25 -6 -14 196 70
2014 05 -4 16 13 5 25 -20
2015 11 2 4 8 0 0 0
2016 15 6 36 14 6 36 36
Σ = 45 Σ = 82 Σ = 40 Σ = 266
¯ 45 ¯ 40 89
RL = =9 RK = =8
5 5
∑N
i = 1ൣRL -R L ൧ൣRK -R K ൧ 89
Covariance = = = 17.8
N 5
162
Return and Standard Deviation of Security L

45
RL = =9
5
¯ 2
ඩ(R^L -RL )
σL =
N
82
σL = √ = 4.05
5
Standard Deviation of Security K
¯ 2
ඩ(RK -RK )
σK =
N
266
σK = √ = 7.29
5
Portfolio Return
RP = 0.50 × 9 + 0.50 × 8 = 8.50%
Portfolio Standard Deviation

σ = (0.502 × 4.052 + 0.502 × 7.292 + 2 × 0.5 × 0.5 × 17.8)½ = 5.125%
LK
Question 4
Ramesh has identified stocks of two companies A and B having good investment potential:
Following data is available for these stocks:
A (Market Price B (Market Price
Year
per Share in ₹) per Share in ₹)
2013 19.60 8.70
2014 18.75 12.80
2015 33.42 16.20
2016 42.64 18.25
2017 43.25 15.60
2018 44.60 13.25
2019 34.75 18.60

(i) The Risk and Return by investing in Stock A and B
163
(ii) The Risk and Return by investing in a portfolio of these Stocks if he invests in Stock
A and B in proportion of 6:4.
(iii) The better oppo rtunity for investment
Jan 21 (New) (10 Marks)
Answer:
A B
Year Market Price Return Return - A̅ Squared Market Price Return Return - B̅ Squared (Return - A̅ ) ×
Per (%) Per Share in (%) (Return - B̅ )
Share in ₹ ₹
2013 19.60 8.70
2014 18.75 -4.34 -18.33 335.9889 12.80 47.13 30.94 957.2836 -567.1302
2015 33.42 78.24 64.25 4128.0625 16.20 26.56 10.37 107.5369 666.2725
2016 42.64 27.59 13.60 184.9600 18.25 12.65 -3.54 12.5316 -48.1440
2017 43.25 1.43 -12.56 157.7536 15.60 -14.52 -30.71 943.1041 385.7176
2018 44.60 3.12 -10.87 118.1569 13.25 -15.06 -31.25 976.5625 339.6875
2019 34.75 -22.09 -36.08 1301.7664 18.60 40.38 24.19 585.1561 -872.7752
83.95 6226.6883 97.14 3582.1748 -96.3718
Mean (A̅ ) 13.99 Variance 1037.7814 Mean (B̅ ) 16.19 Variance 597.0291 Cov.= -16.0620
(i) Return A = 13.99% and Risk (SD) = √1037.7814 = 32.2146 and

Return B = 16.19% and Risk (SD) = √597.0291= 24.4342
(ii) Return of Portfolio = 0.60 × 13.99% + 0.40 × 16.19% = 14.87%

Risk (Standard Deviation) of Portfolio
= [0.602 × 1037.7814 + 0.402 × 597.0291 + 2 × 0.60 × 0.40 × (-16.0620)]½
= [373.6013 + 95.5247- 7.7098]½ = 21.4806
(iii) On the basis of Return ‘B’ is preferable and on the basis of Risk ‘Portfolio Investment’
is preferable over the individual stocks.
Question 5
Standard deviation of security A = 40
Standard deviation of security B = 20
Proportion of investment in A = 0.4 and in B = 0.6
Calculate the standard deviation of portfolio when correlation coefficient is
(i) 1
(ii) -1
(iii) 0 StudyMat
164
Answer:
2 2
σp = √(Wa σa ) +(Wb σb ) +2Wa Wb σa σb rab
(i) When r = 1
2 2
σp = √(0.40 × 40) +(0.60 × 20) +2 × 0.40 × 0.60 × 40 × 20 × 1
σp = ඥ256+144+384
σp = ඥ784
σp = 28
Alternatively,
2 2
σp = √(Wa σa ) +(Wb σb ) +2Wa σa Wb σb
2
σp = √a2 +b2 +2abσp = √(a+b)
σp = a + b
σp = Wa σa +Wb σb
σp = 0.40 × 40 + 0.60 × 20
σp = 16 + 12
σp = 28%
When r = 1, No risk reduction is possible through diversification & hence portfolio
risk is simply the weighted average risk.
(ii) When r = -1
2 2
σp = √(Wa σa ) +(Wb σb ) -2Wa σa Wb σb
2
σp = √a2 +b2 -2abσp = √(a-b)
σp = a-b
σp = Wa σa -Wb σb
σp = 0.40 × 40-0.60 × 20
σp = 16-12
σp = 4%
165
(iii) When r = 0
2 2
σp = √(Wa σa ) +(Wb σb )
2 2
σp = √(0.40 × 40) +(0.60 × 20)
σp = ඥ256+144
σp = ඥ400
σp = 20%
Question 6
Following is the data regarding six securities:
A B C D E F
Return (%) 8 8 12 4 9 8
Risk (Standard deviation) 4 5 12 4 5 6
(i) Assuming three will have to be selected, state which ones will be picked.
(ii) Assuming perfect correlation, show whether it is preferable to invest 75% in A and
25% in C or to invest 100% in E.
MTP April 2021 (8 Marks), RTP Nov 17, MTP Mar 17 (8 Marks), MTP Aug 17 (8 Marks), MTP
Mar 18 (New) (7 Marks), Practice Manual, StudyMat
Answer:
(i) Security A has a return of 8% for a risk of 4, whereas B and F have a higher risk for
the same return. Hence, among them A dominates.
For the same degree of risk 4, security D has only a return of 4%. Hence, D is also
dominated by A.
Securities C and E remain in reckoning as they have a higher return though with
higher degree of risk. Hence, the ones to be selected are A, C & E.
(ii) The average values for A and C for a proportion of 3 : 1 will be :
ሺ3 × 4ሻ+(1 × 12)
Risk = = 6%
4
ሺ3 × 8ሻ+(1 × 12)
Return = = 9%
4
Therefore, 75% A E
25% C -
Risk 6 5
Return 9% 9%
For the same 9% return the risk is lower in E. Hence, E will be preferable.
166
Question 7
Consider the following data
A B
¯ 20% 25%
𝐫
𝛔 50% 30%
𝐑 𝐚𝐛 -0.60
Now suppose the portfolio is constructed with 40% of the funds invested in A and balance 60%
in B.
a. Expected Return of the portfolio
b. Variance of the portfolio
c. Standard deviation of the portfolio
d. State whether diversification has resulted in reduction of risk?
StudyMat
Answer:
a. Portfolio Return
Rp = ∑Ri Wi
= RA WA + RB WB
= 20 × 0.40+25 × 0.60
= 8+15
Rp = 23%
b. Portfolio Variance
2 2
σp 2 = (WA σA ) +(WB σB ) +2WA WB σA σB rAB
2 2
σp 2 = (0.40 × 50) +(0.60 × 30) +20.40 × 0.60 × 50 × 30 × -0.60
σp 2 = 400+324-432
σp 2 = 292
c. Portfolio Standard Deviation

σp = √Variance
σp = ඥ292
σp = 17.09%
d. Risk reduction is not possible through diversification if r = 1 Means it does not

make sense investing in two or more securities in such case.
167
Hence, we will compare the actual risk (17.09%) with a portfolio risk without any
reduction [i.e. when r = 1]
σp = Wa σa +Wb σb
σp = 0.40 × 50+0.60 × 30
σp = 20+18
σp = 38%
Without any reduction σp = 38%

Actual Risk σp = 17.09%
Hence, we can say that diversification has resulted into risk reduction.
Question 8
Calculate the risk of the following multiple asset portfolio
Security Xi σi Correlation coefficient
X 0.25 16 X and Y = 0.7
Y 0.35 7 X and Z = 0.3
Z 0.40 9 Y and Z = 0.4
It may be noted that the correlation coefficient between X and X, Y and Y, Z and Z is 1.
StudyMat
Answer:
2
𝛔𝟐𝐩 = (a + b + c)
= a2 + b2 + c2 + 2ab + 2bc + 2ca
2
= ሺWx σx ሻ2 +൫Wy σy ൯ +ሺWz σz ሻ2 +2Wx σx Wy σy rxy +2Wy σy Wz σz ryz +2Wz σz Wx σx rzx
= (0.25 × 16)2 + (0.35 × 7)2 + (0.40 × 9)2 +2 × 0.25 × 16 × 0.35 × 7 × 0.7+2 × 0.35 × 7 ×
0.40 × 9 × 0.4+ 2 × 0.40 × 9 × 0.25 × 16 × 0.3
= 16 + 6 + 12.96 + 13.72 + 7.06 + 8.64
Variance = 64.38
SD = ඥ64.38
σ2p = 8.02%
168
Question 9
Consider the following information on two stocks, A and B.
Year Return on A (%) Return on B (%)
2016 10 12
2017 16 18

(i) The expected return on a portfolio containing A and B in the proportion of 40% and 60%
respectively.
(ii) The Standard Deviation of return from each of the two stocks.
(iii) The Covariance of returns from the two stocks.
(iv) The Correlation coefficient between the returns of the two stocks.
(v) The risk of a portfolio containing A and B in the proportion of 40% and 60%.
Nov 08 (5 Marks), Nov 2010 (8 Marks), MTP Sept 14 (8 Marks), May 18 (New) (10
Marks), RTP May 20 (Old), Practice Manual, StudyMat
Answer:
(i) Expected return of portfolio A and B
E (A) = (10 + 16) / 2 = 13%
E (B) = (12 + 18) / 2 = 15%.
N
Rp = ∑ Xi Ri = 0.4ሺ13ሻ+0.6ሺ15ሻ = 14.2%
i-1
(i) Stock A:
Variance = 0.5 (10 – 13)² + 0.5 (16 – 13)² = 9
Standard deviation = ඥ9 = 3%
Stock B:
Variance = 0.5 (12 – 15)² + 0.5 (18 – 15)² = 9
Standard deviation = ඥ9 = 3%
(ii) Covariance of stocks A and B

CovAB = 0.5 (10 – 13) (12 – 15) + 0.5 (16 – 13) (18 – 15) = 9
(iii) Correlation Coefficient

CovAB 9
rAB = = = 1
σA σB 3×3
169
(iv) Portfolio Risk

σp = √X2A σ2A +X2B σ2B +2XA XB (σA σB rAB )
2 2 2
= √(0.4 )(32 )+(0.6) (3) +2ሺ0.4ሻሺ0.6ሻሺ3ሻሺ3ሻ(1)
= √1.44+3.24+4.32
= 3%
Question 10
Mr. A is interested to invest ₹1,00,000 in the securities market. He selected two securities B and
D for this purpose. The risk return profile of these securities are as follows:
Security Risk (σ) Expected
Return (ER)
B 10% 12%
D 18% 20%
Co-efficient of correlation between B and D is 0.15.

You are required to calculate the portfolio return of the following portfolios of B and D to be
considered by A for his investment.
(i) 100 percent investment in B only;
(ii) 50 percent of the fund in B and the rest 50 percent in D;
(iii) 75 percent of the fund in B and the rest 25 percent in D; and
(iv) 100 percent investment in D only.
Also indicate that which portfolio is best for him from risk as well as return point of view?
MTP March 22 (8 Marks), RTP Nov 21(New), RTP Nov 21(Old), Practice Manual, StudyMat
Answer:
We have Ep = W1 E1 + W3 E3 +………… Wn En
And for Standard Deviation
n n
σ2p = ∑ ∑ wi wj σij
i=1j=1
n n
σ2p = ∑ ∑ wi wj ρij σi σj
i=1j=1
Two asset portfolio

σ2p = w21 σ21 +w22 σ22 +2w1 w2 σ1 σ2 ρ12
Substituting the respective values we get,

170
(i) All funds invested in B

Ep = 12%
σp = 10%
(ii) 50% of funds in each of B & D

Ep = 0.50 × 12% + 0.50 × 20% = 16%
σ2p = (0.50)2 (10%)2 + (0.50)2 (18%)2 + 2(0.50)(0.50)(0.15)(10%)(18%)
σ2p = 25 + 81 + 13.5 = 119.50
σp = 10.93%
(iii) 75% in B and 25% in D

Ep = 0.75% × 12% + 0.25% × 20 = 14%
σ2p = (0.75)2 (10%)2 + (0.25)2 (18%)2 + 2(0.75)(0.25)(0.15)(10%)(18%)
σ2p = 56.25 + 20.25 + 10.125 = 86.625
σp = 9.31%
(iv) All funds in D

Ep = 20%
σp = 18.0%
Portfolio (i) (ii) (iii) (iv)
Return 12 16 14 20
σ 10 10.93 9.31 18
In the terms of return, we see that portfolio (iv) is the best portfolio. In terms of risk we
see that portfolio (iii) is the best portfolio.
Question 11
Mayuri is interested to construct a Portfolio of Securities X and Y. She has collected the following
information:
X Y
Expected Return (ER) 19% 23%
Risk ( σ ) 14% 18%
Mayuri has 5 Portfolio options of X and Y as follows:

(i) 50% of funds in each X and Y
(ii) 75% of funds in X and 25% in Y
(iii) 25% of funds in X and 75% in Y
171
(iv) 60% of funds in X and 40% in Y

(v) 35% of funds in X and 65% in Y
Co-efficient of correlation (r) between X and Y is 0.16. You are required to calculate:
(i) Expected Return under different Portfolio Options.
(ii) Risk Factor associated with these Portfolio Options.
(iii) Which Portfolio is best from the point of view of Risk?
(iv) Which Portfolio is best from the point of view of Return?
MTP Oct 21 (New) (10 Marks), MTP Oct 21 (Old) (10 Marks), Nov 20 (Old) (8 Marks), RTP May 22
Answer:
We have Ep = W1 E1 + W3 E3 +…………… Wn En
n n
and for standard deviationσ2p = ∑ ∑ wi wj σij

i=1j=1
Two asset portfolio

σ2p = w21 σ21 +w22 σ22 +w1 w2 σ1 σ2 ρ12
Or
σ2p = √w1 σ1 +w2 σ2 +2w1 w2 σ1 σ2 ρ12

Substituting the respective values we get,
(i) 50% of funds in each of X and Y
Ep = 0.50 × 19% + 0.50 × 23% = 21%
σ2p = (0.50)2 (14%)2 + (0.50)2 (18%)2 + 2(0.50) (0.50) (0.16) (14%) (18%)
σ2p = 49 + 81 + 20.16 = 150.16
σp = 12.25%
(ii) 75% in X and 25% in Y

Ep = 0.75 × 19% + 0.25 × 23% = 20%
σ2p = (0.75)2 (14%)2 + (0.25)2 (18%)2 + 2(0.75) (0.25) (0.16) (14%) (18%)
σ2p = 110.25 + 20.25 + 15.12 = 145.62
σp = 12.07%
(iii) 25% in X and 75% in Y

Ep = 0.25 × 19% + 0.75 × 23% = 22%
σ2p = (0.25)2 (14%)2 + (0.75)2 (18%)2 + 2(0.25) (0.75) (0.16) (14%) (18%)
σ2p = 12.25 + 182.25 + 15.12 = 209.62
σp = 14.48%
172
(iv) 60% in X and 40% in Y

Ep = 0.60 × 19% + 0.40 × 23% = 20.6%
σ2p = (0.60)2 (14%)2 + (0.40)2 (18%)2 +2(0.60) (0.40) (0.16) (14%) (18%)
σ2p = 70.56 + 51.84 + 19.35 = 141.75
σp = 11.91%
(v) 35% in X and 65% in Y

Ep = 0.35 × 19% + 0.65 × 23% = 21.6%
σ2p = (0.35)2 (14%)2 + (0.65)2 (18%)2 +2(0.35) (0.65) (0.16) (14%) (18%)
σ2p = 24.01 + 136.89 + 18.35 = 179.25
σp = 13.39%
Portfolio (i) (ii) (iii) (iv) (v)
Return 21 20 22 20.6 21.6
σ 12.25 12.07 14.48 11.91 13.39
In the terms of return, we see that portfolio (iii) is the best portfolio.
In terms of risk we see that portfolio (iv) is the best portfolio.
Question 12
On 01/04/2020 Mr. K invested in the following Companies to make his portfolio:
Name of No. of Equity Face Value per Purchase Price per
Company Share Purchase Equity Share Equity Share
PK Ltd. 2000 ₹10 ₹210
KD Ltd. 1000 ₹10 ₹290
Mr. K expects that –

(i) Dividend for the financial year 2020-21 of PK Ltd. KD Ltd. will be 40% & 50%
respectively.
(ii) Probabilities of the Market Price as on 31/03/2021 as under-
Probability Market Value per Equity Market Value per Equity
Factor Share of PK Ltd. Share pf KD Ltd.
0.4 ₹200 ₹300
0.4 ₹240 ₹320
0.2 ₹260 ₹350
You are required to –
(i) Calculate the Expected Market Price of Equity Shares of both the Companies as on
31/03/2021.
(ii) Calculate the Expected Average Return of the Portfolio for the year 2020-21.
Dec 21 (New) (8 Marks)
173
Answer:
(i) Expected Market Price of Shares on 31/03/2021
PK Ltd. KD Ltd.
(200 × 0.4) + (240 × 0.4) + (260 × 0.2) 228.00 -
(300 × 0.4) + (320 × 0.4) + (350 × 0.2) - 318.00
(ii) Calculation of estimated return on Portfolio for 2020-21

(Calculation in ₹/ share)
PK Ltd. KD Ltd.
Expected dividend 4.00 5.00
Capital gain by 31.03.21 (228 – 210) = 18.00 (318 – 290) = 28.00
Yield 22.00 33.00
Market Value 01.04.20 210 290
% return 10.48% 11.38%
Weight in portfolio
59.15 40.85
(2,000 × 210) : (1000 × 290)
Weighted average (Expected) return
10.85%
(59.15 × 10.48%) + (40.85 × 11.38%)
Question 13
Mr. A, a HNI invested on 1.4.2014 in certain equity shares as below:
Name of Co. No. of shares Cost (₹)
X Ltd. 1,00,000 (₹100 each) 2,00,00,000
Y Ltd. 50,000 (₹10 each) 1,50,00,000
In September 2014, 10% dividend was paid out by X Ltd. and in October 2014, 30% dividend
paid out by Y Ltd. On 31.3.2015 market quotations showed a value of ₹220 and ₹290 per share
for X Ltd. and Y Ltd. respectively.
On 1.4.2015, a technical analyst indicated as follows:
(1) that the probabilities of dividends from X Ltd. and Y Ltd. for the year ending 31.3.2016 are
as below:
Probability factor Dividend from X Ltd. (%) Dividend from Y Ltd. (%)
0.2 10 15
0.3 15 20
0.5 20 35
174
(2) that the probabilities of market quotations on 31.3.2016 are as below:

Probability factor Price/share of X Ltd. Price/share of Y Ltd.
0.2 220 290
0.5 250 310
0.3 280 330

(i) Analyze the average return from the portfolio for the year ended 31.3.2015;
(ii) Analyze the expected average return from the portfolio for the year 2015-16; and
(iii) Advise Mr. A, of the comparative risk in the two investments.
MTP April 22 (8 Marks), MTP Oct 20 (New) (12 Marks), MTP Oct 20 (Old) (12 Marks), May 08 (8
Marks), MTP Feb 14 (10 Marks), RTP Nov 18 (Old), RTP May 19 (New), MTP Apr 19(New) (8
Marks), MTP Apr 19(Old) (8 Marks), Practice Manual
Answer:
(i) Average return from the portfolio for the year ended 31.3.2015
Calculation of return on portfolio (Calculation in
for 2014-15 ₹ / share)
X Ltd. Y Ltd.
Dividend received during the year 10 3
Capital gain/loss by 31.03.15
Market value by 31.03.15 220 290
Cost of investment 200 300
Gain/loss 20 (-)10
Yield 30 (-)7
Cost 200 300
% return 15% (-)2.33%
Weight in the portfolio 57 43 7.55%
Weighted average return
(ii) Average return from the portfolio for the year ended 2015-16 shall be calculated using
the concept of joint probability as follows:
175
X Ltd.
Path Income Gain from Market Total Joint Prob. Exp.

from Price Yield Yield
Dividend (₹) (₹)
(₹) (₹)
1 10 220 – 220 = 0 10 0.20 × 0.20 = 0.04 0.40
2 10 250 – 220 = 30 40 0.20 × 0.50 = 0.10 4.00
3 10 280 – 220 = 60 70 0.20 × 0.30 = 0.06 4.20
4 15 220 – 220 = 0 15 0.30 × 0.20 = 0.06 0.90
5 15 250 – 220 = 30 45 0.30 × 0.50 = 0.15 6.75
6 15 280 – 220 = 60 75 0.30 × 0.30 = 0.09 6.75
7 20 220 – 220 = 0 20 0.50 × 0.20 = 0.10 2.00
8 20 250 – 220 = 30 50 0.50 × 0.50 = 0.25 12.50
9 20 280 – 220 = 60 80 0.50 × 0.30 = 0.15 12.00
Expected Yield (₹) 49.50
Market Value on 01.04.2015 (₹) 220
% Return 22.50
Y Ltd.
Path Income from Gain from Market Total Joint Prob. Exp.
Dividend Price (₹) Yield Yield
(₹) (₹) (₹)

1 1.50 290 – 290 = 0 1.50 0.20 × 0.20 = 0.04 0.06
2 1.50 310 – 290 = 20 21.50 0.20 × 0.50 = 0.10 2.15
3 1.50 330 – 290 = 40 41.50 0.20 × 0.30 = 0.06 2.49
4 2.00 290 – 290 = 0 2.00 0.30 × 0.20 = 0.06 0.12
5 2.00 310 – 290 = 20 22.00 0.30 × 0.50 = 0.15 3.30
6 2.00 330 – 290 = 40 42.00 0.30 × 0.30 = 0.09 3.78
7 3.50 290 – 290 = 0 3.50 0.50 × 0.20 = 0.10 0.35
8 3.50 310 – 290 = 20 23.50 0.50 × 0.50 = 0.25 5.88
9 3.50 330 – 290 = 40 43.50 0.50 × 0.30 = 0.15 6.52
Expected Yield (₹) 24.65
176
Market Value on 01.04.2015 (₹) 290

% Return 8.50
Weight in portfolio (1,00,000 × 220): (50,000 × 290) 60.30 : 39.70

Weighted average (Expected) return (0.6030 × 22.50 + 0.3970 × 8.50) = 16.94%
(iii) To analyze the risk of each investment we need to calculate the Standard Deviation of
each investment as follows:
X Ltd.
Path Prob. Yield Dev. Square of dev. (1) × (2)
(1) (₹) ¯ (2)
Px -Px
1 0.04 10 -39.50 1560.25 62.41
2 0.10 40 -9.50 90.25 9.03
3 0.06 70 20.50 420.25 25.22
4 0.06 15 -34.50 1190.25 71.42
5 0.15 45 -4.50 20.25 3.04
6 0.09 75 25.50 650.25 58.52
7 0.10 20 -29.50 870.25 87.03
8 0.25 50 0.50 0.25 0.06
9 0.15 80 30.50 930.25 139.54
σ2X = 456.27
Standard Deviation (σX) 21.36
Y Ltd.
Path Prob. Yield Dev. Square of dev.
(1) (₹) ¯ (2) (1) × (2)
PY -PY
1 0.04 1.50 -23.15 535.92 21.44
2 0.10 21.50 -3.15 9.92 0.99
3 0.06 41.50 16.85 283.92 17.04
4 0.06 2.00 -22.65 513.02 30.78
5 0.15 22.00 -2.65 7.02 1.05
6 0.09 42.00 17.35 301.02 27.09
177
7 0.10 3.50 -21.15 447.32 44.73

8 0.25 23.50 -1.15 1.32 0.33
9 0.15 43.50 18.85 355.32 53.30
σ2Y = 196.75
Standard Deviation (σY) 14.03
(iv) Although Expected Return is higher in case of X Ltd. but it also has higher risk due to
High S.D.
Question 14
Consider the following asset class returns for calendar year 2016:
Asset Class Portfolio Benchmark Portfolio Benchmark
Weight (%) Weight (%) Return (%) Return (%)
Domestic Equities 55 40 10 8
International Equities 20 30 10 9
Bonds 25 30 5 6
What is the value added (or active return) for the managed portfolio?
Answer:
Portfolio Return = ∑Wi Ri
= 0.55 × 10 + 0.20 × 10 + 0.25 × 5
= 5.5 + 2 + 1.25
= 8.75 %
Market Return = ∑Wi Ri

= 0.40 × 8 + × 0.30 × 9 + 0.30 × 6
= 3.20 + 2.7 + 1.8
= 7.71 %
Active Return [Value Added] = 8.75 – 7.7 = 1.05%
178
Question 15
The historical rates of return of two securities over the past ten years are given. Calculate the
Covariance and the Correlation coefficient of the two securities:
Years: 1 2 3 4 5 6 7 8 9 10
Security 1: 12 8 7 14 16 15 18 20 16 22
(Return per cent)
Security 2: 20 22 24 18 15 20 24 25 22 20
(Return per cent)
Answer:
Year R1 Deviation Deviation R2 Deviation Deviation Product of
¯ 2 ¯ 2
(R1 -R1 )
¯
(R2 -R2 )
¯ deviations
(R1 -R1 ) (R2 -R2 )
1 12 -2.8 7.84 20 -1 1 2.8

2 8 -6.8 46.24 22 1 1 -6.8
3 7 -7.8 60.84 24 3 9 -23.4
4 14 -0.8 0.64 18 -3 9 2.4
5 16 1.2 1.44 15 -6 36 -7.2
6 15 0.2 0.04 20 -1 1 -0.2
7 18 3.2 10.24 24 3 9 9.6
8 20 5.2 27.04 25 4 16 20.8
9 16 1.2 1.44 22 1 1 1.2
10 22 7.2 51.84 20 -1 1 -7.2
148 Σ = 207.60 210 Σ = 84.00
R1 = = 14.8 R2 = = 21
10 10
¯ ¯
∑N
i = 1 ൤R1 -R1 ൨ [R2 -R2 ] 8
Covariance = =- = -0.8
N 10
Standard Deviation of Security 1

¯ 2
ඩ∑(R1 -R1 )
σ1 =
N
207.60
σ1 = √ = ඥ20.76
10
σ1 = 4.56
179
Standard Deviation of Security 2

¯ 2
ඩ∑(R2 -R2 )
σ2 =
N
84
σ2 = √ = ඥ8.40
10
σ2 = 2.90
Alternatively, Standard Deviation of securities can also be calculated as follows:
Calculation of Standard Deviation
Year R1 R12 R2 R22
1 12 144 20 400
2 8 64 22 484
3 7 49 24 576
4 14 196 18 324
5 16 256 15 225
6 15 225 20 400
7 18 324 24 576
8 20 400 25 625
9 16 256 22 484
10 22 484 20 400
148 2398 210 4494
Standard deviation of security 1:

2
N∑R21 -(∑R1 ) ሺ10 × 2398ሻ-ሺ148ሻ2 23980-21904
σ1 = √ =√ =√ = ඥ20.76 = 4.56
N2 10 × 10 100
Standard deviation of security 2:

2
N∑R22 -(∑R2 ) ሺ10 × 4494ሻ-(210)2 44940-44100
σ2 = √ = √ =√ = ඥ8.4 = 2.90
N2 10 × 10 100
Correlation Coefficient
Cov -0.8 -0.8
r12 = = = = -0.0605
σ1 σ2 4.56 × 2.90 13.22
180
Question 16
Mr. Gupta is considering investment in the shares of R. Ltd. He has the following expectations
of return on the stock and the market:
Return (%)
Probability R. Ltd. Market
0.35 30 25
0.30 25 20
0.15 40 30
0.20 20 10
(i) Calculate the expected return, variance and standard deviation for R. Ltd.
(ii) Calculate the expected return variance and standard deviation for the market.
(iii) Find out the beta co-efficient for R. Ltd. shares.
Answer:
(i) Calculation of Expected Return, Variance and Standard Deviation for R Ltd.
Prob.(P) R P×R ¯ ¯ ¯
(R - R) (R – R)2 (R – R)2P
0.35 30 10.50 2 4 1.40

0.30 25 7.50 -3 9 2.70
0.15 40 6.00 12 144 21.60
0.20 20 4.00 -8 64 12.80
28.00 38.50
σ = ඥ38.50 = 6.20
(ii) Calculation of Expected Return, Variance and Standard Deviation for Market
Prob.(P) M P×M ¯ ¯ ¯ ¯ ¯ ¯ ¯
(M -M) (M –M)2 P(M – M)2 (R – R) (M – M) (R – R) (M – M) × P
0.35 25 8.75 3.75 14.063 4.922 7.50 2.625
0.30 20 6.00 -1.25 1.563 0.469 3.75 1.125
0.15 30 4.50 8.75 76.563 11.484 105.00 15.75
0.20 10 2.00 -11.25 126.563 25.313 90.00 18.00
21.25 42.188 37.50
σ = ඥ42.188 = 6.495
181
(iii) Beta Co-efficient for R Ltd. Shares

Cov(R,M) 37.50
β= = = 0.888
σ2M 42.188
Question 17
The distribution of return of security ‘F’ and the market portfolio ‘P’ is given below:
Probability Return %
F P
0.30 30 -10
0.40 20 20
0.30 0 30
You are required to calculate the expected return of security ‘F’ and the market portfolio ‘P’,
the covariance between the market portfolio and security and beta for the security.
RTP May 20 (New), Practice Manual, StudyMat
Answer:
Security F
Prob (P) Rf P × Rf Deviations of F (Deviation)2 of F (Deviations)2 PX
(Rf – ERf)
0.3 30 9 13 169 50.7

0.4 20 8 3 9 3.6
0.3 0 0 -17 289 86.7
ERf = 17 Varf = 141
STDEVσf = √141 = 11.87%
Market Portfolio, P
RM % PM Exp. Return RM Dev. of P 2 2 (Dev. of F) × (Dev. of F) ×
(Dev. of P) (Dev.) PM
× PM (RM -ERM) (Dev of P) (Dev. of P) × P
-10 0.3 -3 -24 576 172.8 -312 -93.6

20 0.4 8 6 36 14.4 18 7.2
30 0.3 9 16 256 76.8 -272 -81.6
ERM = 14 VarM = 264 COVpm = -168
SD(M) = 16.25
CovPM -168
Beta = = = 0.636
σ2M 264
182
Question 18
Given below is information of market rates of Returns and Data from two Companies A and B:
Year 2015 Year 2016 Year 2017
Market (%) 12.0 11.0 9.0
Company A (%) 13.0 11.5 9.8
Company B (%) 11.0 10.5 9.5
You are required to determine the beta coefficients of the Shares of Company A and Company
B.
MTP April 19 (New) (8 Marks), Practice Manual
Answer:
Company A:
Year Return % Market return Deviation Deviation D Ra × Rm2
(Ra) % (Rm) R(a) Rm D Rm
1 13.0 12.0 1.57 1.33 2.09 1.77
2 11.5 11.0 0.07 0.33 0.02 0.11
3 9.8 9.0 -1.63 -1.67 2.72 2.79
34.3 32.0 4.83 4.67
Average Ra = 11.43
Average Rm = 10.67
¯ ¯
∑ (Rm -Rm ) (Ra -Ra ) 4.83
N 3
¯ 2
∑ (Rm -Rm ) 4.67
Variance൫σ2m ൯ = = = 1.557
N 3
1.61
β= = 1.03
1.557
Company B:
Year Return % Market return % Deviation Deviation D Rb × D Rm2
(Rb) (Rm) R(b) Rm Rm
1 11.0 12.0 0.67 1.33 0.89 1.77
2 10.5 11.0 0.17 0.33 0.06 0.11
3 9.5 9.0 -0.83 -1.67 1.39 2.79
31.0 32.0 2.34 4.67
183
Average Rb = 10.33
Average Rm = 10.67
¯ ¯
∑ (Rm -Rm ) (Rb -Rb ) 2.34
N 3
¯ 2
∑ (Rm -Rm ) 4.67
Variance൫σ2m ൯ = = = 1.557
N 3
0.78
β= = 0.50
1.557
Question 19
The following information is available with respect to Jaykay Ltd.
Jaykay Limited Market
Return on
Year Average Average Dividend
DPS govt. bonds
share price Index yield
2002 242 20 1812 4% 6%
2003 279 25 1950 5% 5%
2004 305 30 2258 6% 4%
2005 322 35 2220 7% 5%
Compute beta value of the company as at the end of 2005? What is your observation?
StudyMat
Answer:
D1 +(P1 -P0 )
Returns =
P0
Year SP
2002-2003 25+(279-242)
× 100 = 25.62%
242
2003-2004 30+(305-279)
× 100 = 20.07%
279
2004-2005 35+(322-305)
× 100 = 17.05%
305
184
Calculation of Returns from market Index

Year % of Index Appreciation Dividend Total
Yield % Return %
2002-2003 1950-1812 5% 12.62%
× 100 = 7.62%
1812
2003-2004 2258-1950 6% 21.79%
× 100 = 15.79%
1950
2004-2005 2220-2258 7% 5.32%
× 100 = (-)1.68%
2258
Computation of Beta
Year X Y XY Y2
2002-2003 25.62 12.62 323.32 159.26
2003-2004 20.07 21.79 437.33 474.80
2004-2005 17.05 5.32 90.71 28.30
62.74 39.73
̅=
X ̅=
= 20.91, Y = 13.24
3 3
̅̅̅̅
∑ XY-nXY 851.36 - 3ሺ20.91ሻሺ13.24ሻ 851.36 - 830.55 20.81
β= 2
= 2
= = = 0.15
∑ Y2 -n Y
̅ 662.36-3ሺ13.24ሻ 662.36 - 525.89 136.47
Question 20
The risk premium for the market is 10%. Assuming Beta values of Security K are 0, 0.25, 0.42,
1.00 and 1.67. Compute the risk premium on Security K.
StudyMat
Answer:
Market Risk Premium is 10%
β Value of K Risk Premium of K
0.00 0%
0.25 2.50%
0.42 4.20%
1.00 10.00%
1.67 16.70%
185
Question 21
Suppose if Treasury Bills give a return of 5% and Market Return is 13%, then determine
1. The market risk premium
2. β Values and required returns for the following combination of investments.
Treasury Bill 100 70 30 0

Market 0 30 70 100
RTP May 16, StudyMat
Answer:
1. Market Risk Premium Rm – Rf = 13% - 5% = 8%
2. β is the weighted average of investing in portfolios consisting of market (β = 1) and

beta of treasury bills (β = 0)
Portfolio Treasury β Ri = Rf + b × (Rm – Rf)
Bills: Market
Portfolio
1 100:0 0 5% + 0(13%-5%) 5.00%
2 70:30 0.7(0)+0.3(1) 0.3 5%+0.3(13%-5%) 7.40%
3 30:70 0.3(0)+0.7(1) 0.7 5%+0.7(13%-5%) 10.60%
4 0:100 1 5%+1.0(13%-5%) 13.00%
Question 22
Pearl Ltd. expects that considering the current market prices, the equity shareholders as per
Moderate Approach, should get a return of at least 15.50% while the current return on the market
is 12%. RBI has closed the latest auction for ₹2500 crores of 182 day bills for the lowest bid of
4.3% although there were bidders at a higher rate of 4.6% also for lots of less than ₹10 crores.
What is Pearl Ltd’s Beta?
StudyMat
Answer:
Determining Risk free rate: Two risk free rates are given. The aggressive approach would be to
consider 4.6% while the conservative approach would be to take 4.3%. If we take the moderate
value then the simple average of the two i.e. 4.45% would be considered
Application of CAPM
Rj = Rf + β (Rm – Rf)
15.50% = 4.45% + β (12% - 4.45%)
15.50%-4.45% 11.05
β= = = 1.464
12%-4.45% 7.55
186
Question 23
Information related to an investment is as follows:
Risk free rate 10%
Market Return 15%
Beta 1.2
(i) What would be the return from this investment?

(ii) If the projected return is 18%, is the investment rightly valued?
(iii) What is your strategy?
StudyMat
Answer:
(i) Required rate of Return as per CAPM is given by
Rj = Rf + β (Rm-Rf) = 10 +1.2 (15-10) = 16%
(ii) Since projected return is 18%, the stock is not rightly valued rather undervalued as
return as per CAPM less than Projected Return.
(iii) Had this Project Return is considered as expected return, the decision should be to
BUY the share.
Question 24
The returns and beta of 3 stocks are given below
Stock A B C
Return (%) 18 11 15
Beta Factor 1.7 0.6 1.2
If the risk free rate is 9% and the expected rate of return on the market portfolio is 14% which of
the above stocks are over, under, or correctly valued in the market? What shall be the strategy?
StudyMat
Answer:
A B C
Beta 1.7 0.6 1.2
CAPM 9 + 1.7 (5) 9 + 0.6 (5) 9 + 1.2 (5)
[Rf +β(Rm - Rf)] = 17.5% = 12% = 15%
Actual Return = 18% = 11% = 15%
Valuation Undervalued Overvalued Correctly Valued
Action Buy Sell Hold
187
Question 25
Calculate the market sensitivity index and the expected return on the investment from the
following data:
Standard deviation of an asset 2.5%
Market standard deviation 2.0%
Risk free rate of return 13.0%
Expected return on market portfolio 15.0%
Correlation coefficient of portfolio with market 0.8
Answer:
rpm × σp 0.8 × 2.5
a. Market Sensitivity Index β = = =1
σm 2
b. CAPM Return, Rp = Rf + β(Rm-Rf) = 13 + 1 (15 – 13) = 15%
Question 26
The following information is available in respect of Security A:
Equilibrium Return 12%
Market Return 12%
6% Treasury Bond trading at ₹120
Co-variance of Market Return and Security Return 196%
Coefficient of Correlation 0.80
You are required to determine the Standard Deviation of:
(i) Market Return and

(ii) Security Return Nov 16 (5 Marks)
Answer:
6
(i) Rf = × 100 = 5%
120
Applying CAPM
12% = 5% + β (12% - 5)
7% = β (7%)
β=1
Cov(r,m)
β=
σ2m
196
1=
σ2m
σ2m = 196
σm = ඥ196 = 14
188
Standard Deviation of Market Return = 14

(ii)
Cov(r,m)
rsm =
σm σr
196
0.80 =
14σr
σr = 17.50%
Standard Deviation of Security Return = 17.50%
Question 27
Mr. X is having 1 lakh shares of M/s. Kannyaka Ltd. The beta of the company is 1.40.
Mr. Y a financial advisor has suggested having the following portfolio:
Security Beta % holding
S 1.20 10
K 0.75 10
P 0.40 30
D 1.40 50
100
Market Return is 12%, Risk free rate is 8%
You are required to calculate the following for the present investment and suggested portfolio:
(i) What is the expected return based on CAPM and also
(1) If the market goes up by 2.5%
(2) If the market goes down by 2.5%
(3) If the market gives Negative Returns of 2.5%
(ii) If the probability of market giving negative return is more, please advise Mr. X whether to
continue the holdings of M/s. Kannyaka Ltd. or to buy the portfolio as per the suggestion
of Mr. Y. If so why?
July 21 (Old) (10 Marks), RTP May 22
Answer:
(a) Working Notes –
Calculation of Portfolio Beta suggested by Mr. Y
Security Beta Wt. of Holding Beta × Wt. of Holding
S 1.20 0.1 0.120
K 0.75 0.1 0.075
P 0.40 0.3 0.120
D 1.40 0.5 0.700
Total 1.0 1.015
189
Portfolio Beta is 1.015

Calculation of Expected Return based on CAPM at present situation-
Particulars Risk Beta Market Risk Beta × Expected
Free Return Premium = Risk Return
Rate (Rf) Rm-Rf Premium
a b c d e=d-b f=c×e g=b+f
Kannyaka Ltd. 8 1.400 12 4 5.600 13.60
Portfolio 8 1.015 12 4 4.060 12.06
(i)
(1) Calculation of Expected Return based on CAPM at present situation -
Particulars Risk Free Beta Market Risk Beta × Risk Expected
Rate (Rf) Return Premium= Premium Return
Rm- Rf
Kannyaka Ltd. 8 1.400 14.5 6.5 9.100 17.10
Portfolio 8 1.015 14.5 6.5 6.598 14.60
(2) Calculation of Expected Return based on CAPM if market goes down by 2.5%:
Particulars Risk Free Beta Market Risk Beta × Risk Expected
Rate(Rf) Return Premium= Premium Return
Rm - Rf
Kannyaka Ltd. 8 1.400 9.5 1.5 2.100 10.10
Portfolio 8 1.015 9.5 1.5 1.523 9.52
(3) Calculation of Expected Return based on CAPM if market gives negative returns of
2.5%
Particulars Risk Beta Market Risk Beta × Expected
Free Return Premium= Risk Return
Rate(Rf) Rm-Rf Premium
a b c d e=d-b f=c×e G=b+f
Kannyaka Ltd. 8 1.400 -2.5 -10.5 -14.700 -6.70
Portfolio 8 1.015 -2.5 -10.5 -10.658 -2.66
(ii) If the probability of market giving negative return is more, It is advisable to Mr.X to buy
the portfolio suggested by Mr.Y because Beta of portfolio is less than of Kannyaka Ltd.
190
Question 28
XYZ Ltd. paid a dividend of ₹2 for the current year. The dividend is expected to grow at 40%
for the next 5 years and at 15% per annum thereafter. The return on 182 days T- bills is 11%
per annum and the market return is expected to be around 18% with a variance of 24%. The
co-variance of XYZ's return with that of the market is 30%. You are required to calculate the
required rate of return and intrinsic value of the stock.
May 16 (8 Marks), Practice Manual
Answer:
Covariance of Market Return and Security Return 30%
β= = = 1.25
Variance of Market Return 24%
Expected Return = Rf + β (Rm - Rf)
= 11% + 1.25(18% - 11%)
= 11% + 8.75%
= 19.75%
Intrinsic Value
Year Dividend (₹) PVF (19.75%,n) Present Value (₹)
1 2.80 0.835 2.34
2 3.92 0.697 2.73
3 5.49 0.582 3.19
4 7.68 0.486 3.73
5 10.76 0.406 4.37
16.36
10.76ሺ1.15ሻ
PV of Terminal Value = × 0.406 = ₹105.77
0.1975-0.15
Intrinsic Value = ₹ 16.36 + ₹ 105.77 = ₹ 122.13
Question 29
ABC Ltd. has been maintaining a growth rate of 10 percent in dividends. The company has
paid dividend @ ₹3 per share. The rate of return on market portfolio is 12 percent and the risk-
free rate of return in the market has been observed as 8 percent. The Beta co-efficient of
company’s share is 1.5.
You are required to calculate the expected rate of return on company’s shares as per
CAPM model and equilibrium price per share by dividend growth model.
Nov 10 (5 Marks), MTP Sept 16 (5 Marks), MTP Aug 18 (Old) (6 Marks), Practice Manual
Answer:
191
CAPM formula for calculation of Expected Rate of Return is:

ER = Rf + β (Rm – Rf)
= 8 + 1.5 (12 – 8)
= 8 + 1.5 (4)
=8+6
= 14% or 0.14
Applying Dividend Growth Model for the calculation of per share equilibrium price:
D1
ER = +g
P0
3ሺ1.10ሻ
0.14 = +0.10
P0
3.30
0.14-0.10 =
P0
0.04P0 = 3.30
3.30
P0 =
0.04
P0 = 82.50
Per share equilibrium price will be ₹82.50.
Question 30
Amal Ltd. has been maintaining a growth rate of 12% in dividends. The company has paid
dividend @ ₹3 per share. The rate of return on market portfolio is 15% and the risk-free rate of
return in the market has been observed as 10%. The beta co-efficient of the company’s share
is 1.2.
You are required to calculate the expected rate of return on the company’s shares as per CAPM
model and the equilibrium price per share by dividend growth model.
Nov 10 (5 Marks), MTP Sept 16 (5 Marks), MTP Aug 18 (Old) (6 Marks), StudyMat
Answer:
Capital Asset Pricing Model (CAPM) formula for calculation of expected rate of return is
ER = Rf + β (Rm – Rf)
ER = Expected Return
β = Beta of Security
Rm = Market Return
Rf = Risk free Rate
= 10 + [1.2 (15 – 10)]
= 10 + 1.2 (5)
= 10 + 6 = 16% or 0.16
192
Applying dividend growth mode for the calculation of per share equilibrium price:-
D1
ER = +g
P0
3(1.12) 3.36
or, 0.16 = +0.12 or 0.16-0.12 =
P0 P0
3.36
or 0.04P0 = 3.36 or P0 = = ₹84
0.04
Therefore, equilibrium price per share will be ₹84.
Question 31
M/s X Ltd. has paid a dividend of ₹2.5 per share on a face value of ₹10 in the financial year
ending on 31st March, 2009. The details are as follows:
Current market price of share ₹60
Growth rate of earnings and dividends 10%
Beta of share 0.75
Average market return 15%
Risk free rate of return 9%
Calculate the intrinsic value of the share.
StudyMat
Answer:
D1
Intrinsic Value P0 =
(ke -g)
Using CAPM
k = Rf + β (Rm – Rf) = 9% + 0.75 (15% - 9%) = 13.5%
2.5 × 1.1 2.75

P= = = ₹78.57
0.135-0.10 0.035
Question 32
Following are the details of X Ltd. and Y Ltd.:
Particulars X Ltd. Y Ltd.
Dividend per Share ₹4 ₹4
Growth Rate 10% 10%
Beta 0.9 1.2
Current Market Price ₹150 ₹70
193
Other Information:
Risk Free Rate of Return 7%
Market Rate of Return 14%
(i) Calculate the price of shares of both the companies.

(ii) Write the comment on the valuation on the basis of price calculated and current market
price.
(iii) As an investor what course of action should be followed?
Dec 21 (New) (8 Marks), RTP Nov 15, MTP Feb 15 (8 Marks)
Answer:
(i) Calculation of Prices of shares of both companies
X Ltd. Y Ltd.
Beta 0.9 1.20
Cost of Equity using CAPM 7% + 0.9 [14% - 7%] 7% + 1.20 [14% - 7%]
= 13.30% = 15.40%
Growth Rate 10% 10%
Price of Share 4×1.10 4.40 4×1.10 4.40
= =
0.133-0.10 0.033 0.154-0.10 0.054
=₹133.33 =₹81.48
(ii) and (iii)

Name of Current Value of the Valuation Action of the
Company Market Price Share Investor
X Ltd. ₹150.00 ₹133.33 Overvalued/ Not to Invest/
overpriced to be sold
Y Ltd. ₹70.00 ₹81.48 Undervalued/ Invest/ to be
under-priced purchased
Alternatively, if the given figure of Dividend is considered as Dividend Expected (D1)

then solution will be as follows:
X Ltd. Y Ltd.
Beta 0.9 1.20
7% + 0.9[14% - 7%] 7% + 1.20[14% - 7%]
Cost of Equity using CAPM
= 13.30% = 15.40%
Growth Rate 10% 10%
4.00 4.00 4.00 4.00
= =
Price of Share 0.133-0.10 0.033 0.154-0.10 0.054
=₹121.21 =₹74.07
194
(ii) and (iii)

Name of Current Value of the Valuation Action of the
Company Market Price Share Investor
X Ltd. ₹150.00 ₹121.21 Overvalued / Not to Invest/to
overpriced be sold
Y Ltd. ₹70.00 ₹74.07 Undervalued / Invest/to be
under-priced purchased
Question 33
An investor is holding 1,000 shares of Fatlass Company. Presently the rate of dividend being
paid by the company is ₹2 per share and the share is being sold at ₹25 per share in the market.
However, several factors are likely to change during the course of the year as indicated below:
Existing Revised
Risk free rate 12% 10%
Market risk premium 6% 4%
Beta value 1.4 1.25
Expected growth rate 5% 9%
In view of the above factors whether the investor should buy, hold or sell the shares? And why?
Nov 14 (6 Marks), May 2016 (8 Marks), MTP Sept 15 (8 Marks), MTP March 18 (Old) (8 Marks),
Practice Manual
Answer:
On the basis of existing and revised factors, rate of return and price of share is to be calculated.
Existing rate of return
= Rf + Beta (Rm – Rf)
= 12% + 1.4 (6%) = 20.4%
Revised rate of return

= 10% + 1.25 (4%) = 15%
Price of share (original)

D(1+g) 2 (1.05) 2.10
Po = = = = ₹13.63
ke -g .204-.05 .154
Price of share (Revised)

2 (1.09) 2.18
Po = = = ₹36.33
0.15-0.09 .06
195
In case of existing market price of ₹25 per share, rate of return (20.4%) and possible
equilibrium price of share at ₹13.63, this share needs to be sold because the share is
overpriced (₹25 – 13.63) by ₹11.37. However, under the changed scenario where growth of
dividend has been revised at 9% and the return though decreased at 15% but the possible
price of share is to be at ₹36.33 and therefore, in order to expect price appreciation to
₹36.33 the investor should hold the shares, if other things remain the same.
Question 34
An investor is holding 5,000 shares of X Ltd. Current year dividend rate is ₹3/ share. Market
price of the share is ₹40 each. The investor is concerned about several factors which are likely
to change during the next financial year as indicated below:
Current Year Next Year
Dividend paid /anticipated per share (₹) 3 2.5
Risk free rate 12% 10%
Market Risk Premium 5% 4%
Beta Value 1.3 1.4
Expected growth 9% 7%
In view of the above, advise whether the investor should buy, hold or sell the shares.
Nov 14 (6 Marks), StudyMat
Answer:
On the basis of existing and revised factors, rate of return and price of share is to be calculated.
Existing rate of return
= Rf + Beta (Rm – Rf)
= 12% + 1.3 (5%) = 18.5%
Revised rate of return

= 10% + 1.4 (4%) = 15.60%
Price of share (original)
D(1+g) 3(1.09) 3.27
P0 = = = = ₹34.42
Ke -g 0.185-0.09 0.095
Price of share (Revised)

2.50(1.07) 2.675
P0 = = = ₹31.10
0.156-0.07 0.086
196
Market price of share of ₹40 is higher in comparison to current equilibrium price of ₹34.42
and revised equity price of ₹31.10. Under this situation investor should sell the share.
Question 35
Sunrise Limited last year paid dividend of ₹20 per share with an annual growth rate of 9%. The
risk-free rate is 11% and the market rate of return is 15%. The company has a beta factor of
1.50. However, due to the decision of the Board of Director to grow in organically in the recent
past beta is likely to increase to 1.75.
You are required to find out under Capital Asset Pricing Model
a. The present value of the share
b. The likely value of the share after the decision.
RTP May 17, Practice Manual, StudyMat
Answer:
The value of Cost of Equity with the help of CAPM
Ke = Rf + β (Rm – Rf)
With the given data the Cost of Equity using CAPM will be:
Ke = 0.11 + 1.5(0.15 – 0.11)
Ke = 0.11 + 1.5(0.04) = 0.17 or 17%
The value of share using the Growth Model:

D0 (1+g) 20(1+0.09) 21.80
P= = = = ₹272.50
Ke -g 0.17-0.09 0.08
However, if the decision of the Board of Directors is implemented, the beta factor is likely to
increase to 1.75.
Therefore,
Ke = 0.11 + 1.75(0.15 – 0.11)
Ke = 0.11 + 1.75(0.04) = 0.18 or 18%
The value of share using the Growth Model:

D0 (1+g) 20(1+0.09) 21.80
P= = = = ₹242.22
Ke -g 0.18-0.09 0.09
Question 36
Seawell Corporation, a manufacturer of do-it-yourself hardware and housewares, reported
earnings per share of €2.10 in 2013, on which it paid dividends per share of €0.69. Earnings are
expected to grow 15% a year from 2014 to 2018, during this period the dividend payout ratio is
expected to remain unchanged. After 2018, the earnings growth rate is expected to drop to a
stable rate of 6%, and the payout ratio is expected to increase to 65% of earnings. The firm has
197
a beta of 1.40 currently, and is expected to have a beta of 1.10 after 2018. The market risk
premium is 5.5%. The Treasury bond rate is 6.25%.
(a) What is the expected price of the stock at the end of 2018?
(b) What is the value of the stock, using the two-stage dividend discount model?
MTP Oct 18 (Old) (8 Marks), RTP May 19 (New), Practice Manual
Answer:
The expected rate of return on equity after 2018 = 0.0625 + 1.10(0.055) = 12.3%
The dividends from 2013 onwards can be estimated as:
Year 2013 2014 2015 2016 2017 2018 2019
Earnings Per Share (€) 2.1 2.415 2.78 3.19 3.67 4.22 4.48
Dividends Per Share (€) 0.69 0.794 0.913 1.048 1.206 1.387 2.91
a. The price as of 2018 = €2.91/ (0.123- 0.06) = €46.19
b. The required rate of return up to 2018 = 0.0625 + 1.4(0.055) = 13.95%. The dividends
up to 2018 are discounted using this rate as follow:
Year PV of Dividend
2014 0.794/1.1395 = 0.70
2015 0.913/(1.1395)2 = 0.70
2016 1.048/(1.1395)3 = 0.70
2017 1.206/(1.1395)4 = 0.72
2018 1.387/(1.1395)5 = 0.72
Total = 3.54
The current price = €3.54 + €46.19/(1.1395)5 = €27.58.
Question 37
SRK Ltd. is a listed company and it has just announced annual dividend for the year ending
2013-14. Earning Per Share (EPS) and Dividend Per Share (DPS) for 5 years is as follows:
2013-14 2012-13 2011-12 2010-11 2009-10
EPS (₹) 14.00 13.60 13.10 12.70 12.20
DPS (₹) 8.20 8.10 7.90 7.80 7.70
In the opinion of MD of SRK Ltd., if current dividend policy is maintained annual growth in
Earning and Dividends will be no better than the annual growth in earnings over the past years.
Since the Board of SRK Ltd. is reluctant to take debt to finance growth it is considering changing
198
its dividend policy by retaining 50% of its earnings for investment in various projects having a
post-tax rate of return of 15%. The beta of SRK Ltd. is 1.5, market risk premium is 4% and
Risk Free Rate of Return is 6%.
You are required to calculate expected market price of share, if
1. SRK Ltd. does not announce a change in its Dividend Policy.
2. SRK Ltd. does announce a change in its Dividend Policy by retaining 50% of its
earnings.
Note: Growth Rate can be assumed to be remain stable.
Answer:
Working Notes:
Required Rate of Return using CAPM 6% + 1.5(10% - 6%) = 12%
14.00 1/4
Average Growth Rate = ( ) -1 = 3.5%
12.20
Payout Ratio
8.20+8.10+7.90+7.80+7.70 14.00+13.60+13.10+12.70+12.20
= ( )÷( )
5 5
7.94
= = 0.605 or 60%
13.12
1. Market Price of Share using Dividend Valuation Model if there is no change in
Dividend Policy and assuming constant growth rate,
D1 8.20 × 1.035 8.487
P= = = = ₹99.85
Ke -g 0.12-0.035 0.085
2. Market Price of Share using Earning Growth Model assuming retention ratio
inconstant and return on investment perpetual:
Eሺ1-bሻሺ1+brሻ 14.00ሺ1-0.50ሻሺ1+0.50 × 15%ሻ 7.525
P= = = = ₹167.22
ke -br 0.12-ሺ0.50 × 15%ሻ 0.12-0.075
Question 38
The risk free rate of return Rf is 9 percent. The expected rate of return on the market portfolio
Rm is 13 percent. The expected rate of growth for the dividend of Platinum Ltd. is 7 percent. The
last dividend paid on the equity stock of firm A was ₹2.00. The beta of Platinum Ltd. equity stock
is 1.2.
(i) What is the equilibrium price of the equity stock of Platinum Ltd.?
(ii) How would the equilibrium price change when
• The inflation premium increases by 2 percent?
• The expected growth rate increases by 3 percent?
• The beta of Platinum Ltd. equity rises to 1.3?
199
Nov 14 (8 Marks), May 18 (New) (4 Marks), MTP March 19 (New) (8 Marks), Practice Manual, StudyMat
Answer:
(i) Equilibrium price of Equity using CAPM
= 9% + 1.2(13% - 9%)
= 9% + 4.8% = 13.8%
D1 2.00(1.07) 2.14
= = = = ₹31.47
ke -g 0.138-0.07 0.068
(ii) New Equilibrium price of Equity using CAPM

= 9.18% + 1.3(13% - 9.18%)
= 9.18% + 4.966% = 14.146%
D1 2.00(1.10) 2.20
= = = = ₹53.06
ke -g 0.14146-0.10 0.04146
Alternatively, it can also be computed as follows:

= 11% + 1.3(15% - 8%)
= 11% + 5.2% = 16.20%
D1 2.00(1.10)
= = = ₹35.48
ke -g 0.162-0.10
Alternatively, if all the factors are taken separately then solution will be as follows:
(i) Inflation Premium increase by 2%. This raises RX to 15.80%. Hence, new
equilibrium price will be:
2.00(1.07)
= = ₹24.32
0.158-0.07
(ii) Expected Growth rate increases by 3%. Hence, revised growth rate stands at
10%:
2.00(1.10)
= = ₹57.89
0.138-0.10
(iii) Beta rises to 1.3. Hence, revised cost of equity shall be:
= 9% + 1.3(13% - 9%)
= 9% + 5.2% = 14.2%
As a result, New Equilibrium price shall be:
D1 2.00(1.07)
P= = = ₹29.72
ke -g 0.142-0.07
200
Question 39
Your client is holding the following securities:
Particulars of Cost Dividends/ Interest Market Price Beta
Securities ₹ ₹ ₹
Equity Shares:
Gold Ltd. 10,000 1,725 9,800 0.6
Silver Ltd. 15,000 1,000 16,200 0.8
Bronze Ltd. 14,000 700 20,000 0.6
GOI Bonds 36,000 3,600 34,500 0.01
Average return of the portfolio is 15.7%, calculate:

(i) Expected rate of return in each, using the Capital Asset Pricing Model (CAPM).
(ii) Risk free rate of return.
Nov 13 (8 Marks), May 15 (8 Marks), StudyMat
Answer:
Particulars of Securities Cost Dividend Capital gain
₹
Gold Ltd. 10,000 1,725 -200

Silver Ltd. 15,000 1,000 1,200
Bronz Ltd. 14,000 700 6,000
GOI Bonds 36,000 3,600 - 1,500
Total 75,000 7,025 5,500
(i) Expected rate of return on market portfolio

Dividend Earned + Capital Appreciation ₹7,025+₹5,500
× 100 = × 100 = 16.7%
Initial Investment ₹75,000
(ii) Risk free return
0.6+0.8+0.6+0.01 *
Average of Betas = = Average of Betas = 0.50
4
Average return = Risk free return + Average Betas (Expected return – Risk free return)
15.7 = Risk free return + 0.50 (16.7 – Risk free return)
Risk free return = 14.7%
* Alternatively, it can also be calculated through Weighted Average Beta.
Expected Rate of Return for each security is
201
Rate of Return = Rf + β (Rm – Rf)

Gold Ltd. = 14.7 + 0.6 (16.7 – 14.7) = 15.90%
Silver Ltd. = 14.7 + 0.8 (16.7 – 14.7) = 16.30%
Bronz Ltd. = 14.7 + 0.6 (16.7 – 14.7) = 15.90%
GOI Bonds = 14.7 + 0.01 (16.7 – 14.7) = 14.72%
* Alternatively, it can also be computed by using Weighted Average Method.
Question 40
As an investment manager, you are given the following information:
Particulars Initial price Dividend Market price of Beta
the dividends (Risk
(₹) (₹) (₹) factor)
(A) Equity Shares:
Manufacturing Ltd. 30 2 55 0.8
Pharma Ltd. 40 2 65 0.7
Auto Ltd. 50 2 140 0.5
(B) Government of India Bonds 1005 140 1010 0.99
By assuming risk free return as 16%, Calculate:

(i) Expected rate of return on the portfolio (aggregate) of investor;
(ii) Expected rate of return of portfolio in each above stated share/ bond using Capital Asset
Pricing Model (CAPM); and
(iii) Average Rate of Return.
May 18 (Old) (8 Marks), May 08 (10 Marks), MTP Feb 15 (10 Marks), Practice Manual
Answer:
(i) Expected rate of return
Total Investments Dividends Capital Gains
Manufacturing Ltd. 30 2 25
Pharma Ltd. 40 2 25
Auto Ltd. 50 2 90
GOI Bonds 1005 140 5
1,125 146 145
146+145
Expected Return on market portfolio = = 25.87%
1125
202
(ii) CAPM = E(Rp) = Rf + β [E(Rm) – Rf]
Manufacturing Ltd. 16 + 0.8 [25.87-16] = 16 + 7.90 = 23.90%

Pharma Ltd. 16 + 0.7 [25.87-16] = 16 + 6.91 = 22.91%
Auto Ltd. 16 + 0.5 [25.87-16] = 16 + 4.93 = 20.93%
GOI Bonds 16 + 0.99 [25.87-16] = 16 + 9.77 = 25.77%
(iii) Average Return of Portfolio

23.90+22.91+20.93+25.77 93.51
= = 23.38%
4 4
Alternatively,
0.8+0.7+0.5+0.99 2.99
= = 0.7475
4 4
16 + 0.7475(25.87- 16) = 16 + 7.38 = 23.38%
Question 41
Mr. X holds the following portfolio:
Securities Cost (₹) Dividends (₹) Market Price (₹) Beta
Equity shares:
A Ltd. 16,000 1,600 16,400 0.9
B Ltd. 20,000 1,600 21,000 0.8
C Ltd. 32,000 1,600 44,000 0.6
PSU Bonds 68,000 6,800 64,600 0.4
The risk-free rate of return is 12%. Calculate the following:
(i) The expected rate of return on his portfolio using Capital Asset Pricing Model (CAPM).
(ii) The average return on his portfolio. (Calculate up to two decimal points)
Practice Manual, StudyMat, Nov 19 (New) (8 Marks)
Answer:
Calculation of expected return on market portfolio (Rm)
Investment Cost (₹) Dividends (₹) Capital Gains (₹)
Shares A 16,000 1600 400
Shares B 20,000 1600 1000
Shares C 32,000 1600 12,000
PSU Bonds 68,000 6800 –3,400
1,36,000 11,600 10,000
203
11,600+10,000
Rm = × 100 = 15.88%
1,36,000
(i) Calculation of expected rate of return on individual security:

Security
Shares A 12 + 0.9 (15.88 – 12.0) = 15.49%
Shares B 12 + 0.8 (15.88 – 12.0) = 15.10%
Shares C 12 + 0.6 (15.88 – 12.0) = 14.33%
PSU Bonds 12 + 0.4 (15.88 – 12.0) = 13.55%
(ii) Calculation of the Average Return of the Portfolio:

15.49+15.10+14.33+13.55
= = 14.62%
4
Question 42
The following information are available with respect of Krishna Ltd.
Year Krishna Ltd. Dividend Average Dividend Return on
Average share price per Share Market Index Yield Govt. Bonds
2012 245 20 2013 4% 7%
2013 253 22 2130 5% 6%
2014 310 25 2350 6% 6%
2015 330 30 2580 7% 6%
Compute Beta Value of the Krishna Ltd. at the end of 2015 and state your observation.
May 17 (8 Marks), MTP Mar 19 (New) (8 Marks), RTP May 16, Practice Manual
Answer:
(i) Computation of Beta Value
Calculation of Returns
D1 +ሺP1 -P0 ሻ
Returns = × 100
P0
Year Returns
22+ሺ253-245ሻ
2012-13 × 100 = 12.24%
245
25+ሺ310-253ሻ
2013-14 × 100 = 32.41%
253
30+ሺ330-310ሻ
2014-15 × 100 = 16.13%
310
204
Calculation of Returns from market Index
Year % of Index Appreciation Dividend Yield % Total Return %

2012–13 ሺ2130-2013ሻ 5% 10.81%
× 100 = 5.81%
2013
2013–14 2350-2130 6% 16.33%
× 100 = 10.33%
2130
2014–15 ሺ2580-2350ሻ 7% 16.79%
× 100 = 9.79%
2350
Computation of Beta
Year Krishna Ltd. (X) Market Index (Y) XY Y2
2012–13 12.24% 10.81% 132.31 116.86
2013–14 32.41% 16.33% 529.25 266.67
2014–15 16.13% 16.79% 270.82 281.90
Total 60.78% 43.93% 932.38 665.43
60.78
Average Return of Krishna Ltd. = = 20.26%
3
43.93
Average Market Return = = 14.64%
3
¯¯
∑XY-nXY 932.38-3 × 20.26 × 14.64
Betaሺβሻ = 2
= = 1.897
¯ 665.43-3ሺ14.64ሻ2
∑Y2 -n (Y)
(ii) Observation
Expected Return (%) Actual Return (%) Action
2012 – 13 6%+ 1.897(10.81% - 6%) = 15.12% 12.24% Sell
2013 – 14 6%+ 1.897(16.33% - 6%) = 25.60% 32.41% Buy
2014 – 15 6%+ 1.897(16.79% - 6%) = 26.47% 16.13% Sell
205
Question 43
Mr. A has short term investments in shares of the various companies. The detail of these
investments is as follows:
Name of Company No. of Geared Current Current Expected
shares Beta Market Dividend Return
Price ( ₹) Yield (%) (%)
T Ltd. (Face Value ₹50) 1000 1.55 280 6.8 21.00
U Ltd. (Face Value ₹100) 1550 0.65 340 3.6 12.50
V Ltd. (Face Value ₹20) 2600 1.26 150 6.4 18.00
W Ltd. (Face Value ₹10) 4300 1.14 95 7.2 18.50
Risk Free Rate of Return and market return are 6% and 16% respectively.
(i) Estimate the risk of Mr. A’s portfolio relative to market.
(ii) Whether the composition of portfolio should be changed if yes then how.
Answer:
(i) The risk of Mr. A’s portfolio relative to market can be determined by calculating
weighted beta of the portfolio as follows:
Name of Company Geared Beta (βi) Market Value ( ₹) Weights (wi) (βi) × (wi)
T Ltd. 1.55 2,80,000 0.1744 0.2703
U Ltd. 0.65 5,27,000 0.3283 0.2135
V Ltd. 1.26 3,90,000 0.2429 0.3061
W Ltd. 1.14 4,08,500 0.2544 0.2900
1.0799
(ii) Thus, the risk of portfolio relative to market is 1.08

(ii) The individual shares can be examined to provide a satisfactory return for the
systematic risk they involve using CAPM and determine course of action to change the
composition of portfolio as follows:
E(R) = Rf + β (Rm - Rf)
Name of Required Return Expected Alpha Action
Company Return (%) Value
T Ltd. 6% + 1.55(16% - 6%) = 21.50% 21.00 -0.50% Sell Shares
U Ltd. 6% + 0.65(16% - 6%) = 12.50% 12.50 0 Hold
206
V Ltd. 6% + 1.26(16% - 6%) = 18.60% 18.00 -0.60% Sell Shares

W Ltd. 6% + 1.14(16% - 6%) = 17.40% 18.50 1.1% Buy more
shares
Question 44
XYZ Ltd. has substantial cash flow and until the surplus funds are utilized to meet the future
capital expenditure, likely to happen after several months, are invested in a portfolio of short-
term equity investments, details for which are given below:
Investment No. of shares Beta Market price per Expected dividend
share ₹ yield
I 60,000 1.16 4.29 19.50%
II 80,000 2.28 2.92 24.00%
III 1,00,000 0.90 2.17 17.50%
IV 1,25,000 1.50 3.14 26.00%
The current market return is 19% and the risk free rate is 11%.
Required to:
(i) Calculate the risk of XYZ’s short-term investment portfolio relative to that of the
market;
(ii) Whether XYZ should change the composition of its portfolio.
MTP April 14 (8 Marks), RTP May 14, MTP April 18 (New) (4 Marks), RTP May 2020 (Old), Practice Manual,
StudyMat
Answer:
(i) Computation of Beta of Portfolio
Shares No. of Market Market Dividend Dividend Composition β Weighted
shares Price Value Yield β
I 60,000 4.29 2,57,400 19.50% 50,193 0.2339 1.16 0.27
II 80,000 2.92 2,33,600 24.00% 56,064 0.2123 2.28 0.48
III 1,00,000 2.17 2,17,000 17.50% 37,975 0.1972 0.90 0.18
IV 1,25,000 3.14 3,92,500 26.00% 1,02,050 0.3566 1.50 0.53
11,00,500 2,46,282 1.0000 1.46
(ii)
2,46,282
Return of portfolio= = 0.2238
11,00,500
Beta of Portfolio = 1.46

207
Market Risk implicit

0.2238 = 0.11 + β × (0.19 – 0.11)
Or, 0.08 β + 0.11 = 0.2238
0.2238-0.11
β= = 1.42
0.08
Market β implicit is 1.42 while the portfolio β is 1.46. Thus, the portfolio is marginally risky
compared to the market.
(iii) The decision regarding change of composition may be taken by comparing the dividend
yield (given) and the expected return as per CAPM as follows:
Expected return Rs as per CAPM is:
Rs = IRF + (RM – I RF) β
For investment I Rs = IRF + (RM – IRF) β = 0.11 + (0.19 - 0.11) 1.16 =
20.28%
For investment II, Rs = 0.11 + (0.19 - 0.11) 2.28 = 29.24%
For investment III, Rs = 0.11 + (0.19 - 0.11) 0.90 = 18.20%
For investment IV, Rs = 0.11 + (0.19 - 0.11) 1.50 = 23%
Comparison of dividend yield with the expected return Rs shows that the dividend yields
of investment I, II and III are less than the corresponding Rs,. So, these investments are
over-priced and should be sold by the investor. However, in case of investment IV, the
dividend yield is more than the corresponding Rs, so, XYZ Ltd. should increase its
proportion.
Question 45
K Ltd. has invested in a portfolio of short-term equity investments. You are required to calculate
the risk of K Ltd.’s short-term investment portfolio relative to that of the market from the
information given below:
Investment A B C D
No. of shares 1,20,000 1,60,000 2,00,000 2,50,000
Market price per share (₹) 8.58 5.84 4.34 6.28
Beta 2.32 4.56 1.80 3.00
Expected Dividend Yield 9.50% 14.00% 7.50% 16.00%
The current market return is 20% and the risk free return is 10%.
Advise whether K Ltd. should change the composition of its portfolio. If yes, then how.
Note: Make calculations upto 4 decimal points. RTP May 21 (New), RTP May 21 (Old)
208
Answer:
(i) To determine whether K Ltd. should change composition of its portfolio first we should
determine the Beta of the Portfolio and compare it with implicit Beta as justified by the
Return on Portfolio.
Calculation of Beta of Portfolio
Invest- No. of Market Market Dividend Dividend Composition β Weighted
ment shares Price Value Yield β
(₹)
A 1,20,000 8.58 10,29,600 9.50% 97,812 0.2339 2.32 0.5426
B 1,60,000 5.84 9,34,400 14.00% 1,30,816 0.2123 4.56 0.9681
C 2,00,000 4.34 8,68,000 7.50% 65,100 0.1972 1.80 0.3550
D 2,50,000 6.28 15,70,000 16.00% 2,51,200 0.3566 3.00 1.0698
44,02,000 5,44,928 1.0000 2.9355
5,44,928
Return of the Portfolio = = 0.1238
44,02,000
Beta of Portfolio 2.9355

Market Risk implicit
0.1238 = 0.10 + β × (0.20 – 0.10)
Or, 0.10 β + 0.10 = 0.1238
0.1238 0.10
β= = 0.238
0.10
Market β implicit is 0.238 while the portfolio β is 2.93. Thus, the portfolio is marginally
risky compared to the market.
(ii) To decide whether K Ltd. should change the composition of its portfolio the dividend yield
(given) should be compared with the Expected Return as per CAPM as follows:
Expected return as per CAPM is Rf + (RM – Rf) β
Accordingly,
Expected Return for investment A = 0.10 + (0.20 - 0.10) 2.32 = 33.20%
Expected Return for investment B = 0.10 + (0.20 - 0.10) 4.56 = 55.60%
Expected Return for investment C = 0.10 + (0.20 - 0.10) 1.80 = 28%
For investment D, = 0.10 + (0.20 - 0.10) 3 = 40%
209
Comparing dividend yields with the expected returns of investment as per CAPM it can
be observed that all investments are over-priced and they should be sold by the K Ltd.
and acquire new securities.
Question 46
The following information is available for the share of X Ltd. and stock exchange for the last
4 years.
X Ltd. Index of Stock Return from Return from
Exchange Market funds Govt.
Securities
Share Divided
Price Yield
Present Year 197.00 10% 2182 16% 15%
1 year ago 164.20 12% 1983 15% 15%
2 year ago 155.00 8% 1665 16% 16%
3 year ago 121.00 10% 1789 10% 14%
4 year ago 95.00 10% 1490 18% 15%
With above information available please calculate:

i. Expected Return on X Ltd.’s share.
ii. Expected Return on Market Index.
iii. Risk Free Rate of Return
iv. Beta of X Ltd. RTP Nov 11
Answer:
(i) Expected Return on X Ltd.’s Share
Average % Annual Capital Gain [197 ÷ 95] ¼ -1 = 0.20 i.e. 20%
10%+12%+8%+10%+10%
Average % dividend yield: = 10%
5
Therefore, expected return on share of X Ltd. = 20% + 10% = 30%
(ii) Expected Return on Market Index

Average Annual % Capital gain
[2182 ÷ 1490]1/4 -1 = 0.10 i.e. 10%
Average % of dividend yield

16% + 15% + 16% + 10% + 18%
= 15%
5
210
Thus, expected return on Market Index = 10% + 15% = 25%
(iii) Return from Central Govt. Securities

15% + 15% + 16% + 14% +15%
= 15%
5
Thus, Risk Free Rate of Return = Rf = 15%
(iv) Beta Value of X Ltd.

E (Rx) = Rf + [ E(Rm) – Rf] βx
Accordingly,
E(Rx)-Rf 30% -15% 15
= βx = = = 1.50
E(Rm)-Rf 25% -15% 10
Question 47
Following data is related to Company X, Market Index and Treasury Bonds for the current year
and last 4 years:
Year Company X Market Index Return on
Treasury
Average Dividend Per Average Market Bonds
Share Price Share (D) Market Index Dividend
(P) Yield
2009 ₹139 ₹7.00 1300 3% 7%
2010 ₹147 ₹8.50 1495 5% 9%
2011 ₹163 ₹9.00 1520 5.5% 8%
2012 ₹179 ₹9.50 1640 4.75% 8%
2013 ₹203.51 ₹10.00 1768 5.5% 8%
(Current Year)
With the above data estimate the beta of Company X’s share.
RTP Nov 13, RTP May 15
Answer:
First of we shall calculate expected return from share of Company X
(i) Average annual capital gain (%)
Let g = average annual capital gain, then:
₹203.51(1+g)¼ = ₹139
Then g = (203.51/139) ¼ -1 = 0.10 i.e. 10%
211
(ii) Average annual dividend yield (%)

Year Dividend/Share Price Dividend Yield
2009 ₹7.00/ ₹139 0.050
2010 ₹8.50/ ₹147 0.058
2011 ₹9.00/ ₹163 0.055
2012 ₹9.50/ ₹179 0.053
2013 (Current Year) ₹10.00/ ₹203.51 0.049
0.265
Average Yield = 0.265/5 = 0.053 i.e. 5.3%

Thus, with this data expected return of share of Company X can be given as follows:
E(rX) = Average Annual Capital Gain + Average Annual Dividend
= 10% + 5.3% = 15.3%
Then we shall calculate expected return from market index as follows:
(i) Average annual capital gain (%)
1300 (1+g)¼ = 1768
Then g = (1768/1300) ¼ -1 = 0.08 i.e. 8%
(ii) Average annual dividend yield (%)

3% + 5% + 5.5% + 4.75% + 5.5% = 23.75%/5 = 4.75%
Thus, expected return on Market Index E(rM) = 8% + 4.75% = 12.75%
Average annual risk-free rate of return (Treasury Bond Return)

7% + 9% + 8% + 8% + 8% = 40%/5 = 8%
Now with the above information we compute Beta (β) of share of company X using
CAPM as follows:
E(rX) = rf + β [E (rM) - rf]
15.3% = 8% + β [12.75% - 8%]
β = 1.54
212
Question 48
Mr. Tempest has the following portfolio of four shares:
Name Beta Investment ₹ Lac.
Oxy Rin Ltd. 0.45 0.80
Boxed Ltd. 0.35 1.50
Square Ltd. 1.15 2.25
Ellipse Ltd. 1.85 4.50
The risk-free rate of return is 7% and the market rate of return is 14%.
Required.
(i) Determine the portfolio return.
(ii) Calculate the portfolio Beta.
May 11 (5 Marks), MTP Oct 15 (5 Marks), MTP Mar 16 (5 Marks), RTP Nov 18 (Old), MTP Oct 18 (Old)
(6 Marks), MTP Oct 18 (New) (8 Marks), RTP Nov 19 (Old), Practice Manual
Answer:
Market Risk Premium (A) = 14% – 7% = 7%
Share Beta Risk Premium Risk Free Return Return
(Beta × A) % Return % % ₹
Oxy Rin Ltd. 0.45 3.15 7 10.15 8,120
Boxed Ltd. 0.35 2.45 7 9.45 14,175
Square Ltd. 1.15 8.05 7 15.05 33,863
Ellipse Ltd. 1.85 12.95 7 19.95 89,775
Total Return 1,45,933
Total Investment ₹9,05,000
₹1,45,933
(i) Portfolio Return = × 100 = 16.13%
₹9,05,000
(ii) Portfolio Beta

Portfolio Return = Risk Free Rate + Risk Premium × β = 16.13%
7% + 7β = 16.13%
β = 1.30
Alternative Approach
First, we shall compute Portfolio Beta using the weighted average method as follows:
0.80 1.50 2.25 4.45
BetaP = 0.45 × +0.35 × +1.15 × +1.85 ×
9.05 9.05 9.05 9.05
= 0.45 × 0.0884 + 0.35 × 0.1657 + 1.15 × 0.2486 + 1.85 × 0.4972
213
= 0.0398 + 0.058 + 0.2859 + 0.9198

= 1.3035
Accordingly,
(i) Portfolio Return using CAPM formula will be as follows:
Rp = RF + Betap (RM – RF)
= 7% + 1.3035(14% - 7%)
= 7% + 1.3035(7%)
= 7% + 9.1245%
= 16.1245%
(ii) Portfolio Beta = As calculated above 1.3035
Question 49
The total market value of the equity share of O.R.E. Company is ₹60,00,000 and the total value
of the debt is ₹40,00,000. The treasurer estimate that the beta of the stock is currently 1.5 and
that the expected risk premium on the market is 10 per cent. The treasury bill rate is 8 per cent.
Required:
(i) What is the beta of the Company’s existing portfolio of assets?
(ii) Estimate the Company’s Cost of capital and the discount rate for an expansion of the
company’s present business.
MTP Oct 21 (New) (8 Marks), MTP Oct 21 (Old) (5 Marks), RTP Nov 11, RTP May 15, StudyMat
Answer:
(i)
VE VD
βasset = βequity × +βdebt ×
V0 V0
Note: Since βdebt is not given it is assumed that company debt capital is virtually riskless.
If company’s debt capital is riskless than above relationship become:
VE
Here,βequity = 1.5; βasset = βequity
V0
As βdebt = 0
VE = ₹60 lakhs
VD = ₹40 lakhs
V0 = ₹100 lakhs
₹60 lakhs
βasset = 1.5 × = 0.9
₹100 lakhs
214
(ii)
(a) If only equity is used to finance the expansion, the Cost of Capital for discounting
company’s expansion of existing business shall be computed as follows:
Company’s cost of equity = Rf + βA × Market Risk premium
Where Rf = Risk free rate of return, βA = Beta of company assets
Therefore, company’s cost of equity = 8% + 0.9 × 10 = 17% and overall cost of capital
shall be 17%.
(b) Alternatively, if funds expansion are raised for in same proportion as exiting capital
structure, then cost of capital shall be computed as follows:
Cost of Equity = 8% + 1.5 × 10 = 23%
Cost of Debt = 8%
3 2
WACCሺCost of Capitalሻ = 23% × + 8% × = 17%
5 5
Question 50
A company has a choice of investments between several different equity oriented mutual funds.
The company has an amount of ₹100 lakhs to invest. The details of the mutual funds are as
follows:
Mutual Funds A B C D E
Beta 1.5 1.0 0.8 2.0 0.7
PLAN I
If the company invests 20% of its investments in each of the first two mutual funds (A and B)
and balance in equal amounts in the mutual funds C, D and E, what is the beta of the portfolio?
PLAN II
If the company invests 15% of its investment in C, 15% in A, 10% in E and the balance in equal
amounts in the other two mutual funds, what is the beta of the portfolio?
If the expected return of market portfolio is 12% at a beta factor of 1.0, what will be the expected
return on the portfolio in both the plans given above?
July 21 (New) (8 Marks), May 08 (10 Marks), RTP Nov 16, RTP May 17, RTP Nov 18 (Old), Practice Manual
Answer:
Plan I: Investment in A and B at 20 % each and balance in equal proportion in C, D, and
E.
Mutual Fund Proportion of Investment Beta Proportion × Fund beta
A 0.2 1.50 0.30
B 0.2 1.00 0.20
C 0.2 0.80 0.16
D 0.2 2.00 0.40
E 0.2 0.70 0.14
Portfolio beta 1.20
215
Plan II: Investment in A at 15%, C at 15% and E at 10% and balance in equal proportion in
B and D:
Mutual Fund Proportion of Investment Beta Proportion × Fund beta
A 0.15 1.50 0.225
B 0.30 1.00 0.300
C 0.15 0.80 0.120
D 0.30 2.00 0.600
E 0.10 0.70 0.070
Portfolio Beta 1.315
Expected return = Market return × Portfolio Beta

Plan Return
I 12% × 1.20 = 14.40%
II 12% × 1.315 = 15.78%
Question 51
A Ltd. has an expected return of 22% and Standard deviation of 40%. B Ltd. has an expected
return of 24% and Standard deviation of 38%. A Ltd. has a beta of 0.86 and B Ltd. a beta of
1.24. The correlation coefficient between the return of A Ltd. and B Ltd. is 0.72. The Standard
deviation of the market return is 20%. Suggest:
(i) Is investing in B Ltd. better than investing in A Ltd.?
(ii) If you invest 30% in B Ltd. and 70% in A Ltd., what is your expected rate of return and
portfolio Standard deviation?
(iii) What is the market portfolios expected rate of return and how much is the risk-free rate?
(iv) What is the beta of Portfolio if A Ltd.’s weight is 70% and B Ltd.’s weight is 30%?
Practice Manual
Answer:
(i) A Ltd. has lower return and higher risk than B Ltd. investing in B Ltd. is better than in
A Ltd. because the returns are higher and the risk, lower. However, investing in both will
yield diversification advantage.
(ii) rAB = .22 × 0.7 + .24 × 0.3 = 22.6%

σAB2 = 0.402 × 0.72 + 0.382 × 0.32 + 2 × 0.7 × 0.3 × 0.72 × 0.40 × 0.38 = 0.1374
σAB = √σ2AB = √.1374 = .37 = 37%*
* Answer = 37.06% is also correct and variation may occur due to approximation.
(iii) This risk-free rate will be the same for A and B Ltd. Their rates of return are given as
follows:
216
rA = 22 = rf + (rm – rf) 0.86

rB = 24 = rf + (rm – rf) 1.24
rA – rB = –2 = (rm – rf) (–0.38)
rm – rf = –2/–0.38 = 5.26%
rA = 22 = rf + (5.26) 0.86
rf = 17.5%*
rB = 24 = rf + (5.26) 1.24
rf = 17.5%*
rm – 17.5 = 5.26
rm = 22.76%**
*Answer = 17.47% might occur due to variation in approximation.
**Answer may show small variation due to approximation. Exact answer is 22.73%.
(iv) βAB = βA × WA + βB × WB
= 0.86 × 0.7 + 1.24 × 0.3
= 0.974
Question 52
The following information is available in respect of Security X
Equilibrium Return 15%
Market Return 15%
7% Treasury Bond Trading at $140
Covariance of Market Return and Security Return 225%
Coefficient of Correlation 0.75
You are required to determine the Standard Deviation of Market Return and Security Return.
RTP May 13, RTP may 18 (Old), MTP Mar 19 (Old) (5 Marks), MTP Feb 16 (8 Marks), Practice Manual
Answer:
First, we shall compute the β of Security X.
Coupon Payment 7
Risk Free Rate = = = 5%
Current Market Price 140
Assuming equilibrium return to be equal to CAPM return then:
15% = Rf + βX (Rm- Rf)
15% = 5% + βX (15%- 5%)
βX = 1
or it can also be computed as follows:
217
Rm 15%
= =1
Rs 15%
(i) Standard Deviation of Market Return

CovX,m 225%
βm = = =1
σ2m σ2m
σ2m = 225
σm = ඥ225 = 15%
(ii) Standard Deviation of Security Return

σX σX
βm = × rXm = × 0.75 = 1
σm 15
15
σX = = 20%
0.75
Question 53
An investor holds two stocks A and B. An analyst prepared ex-ante probability distribution for
the possible economic scenarios and the conditional returns for two stocks and the market index
as shown below:
Economic scenario Probability Conditional Returns %
A B C
Growth 0.40 25 20 18
Stagnation 0.30 10 15 13
Recession 0.30 -5 -8 -3
The risk free rate during the next year is expected to be around 11%. Determine whether the
investor should liquidate his holdings in stocks A and B or on the contrary make fresh
investments in them. CAPM assumptions are holding true.
RTP Nov 15, RTP May 18 (Old), Nov 09 (10 Marks), Practice Manual
Answer:
Expected Return on stock A = E (A) = ∑ Pi Ai
i = G,S,R
(G, S & R, denotes Growth, Stagnation and Recession)

(0.40)(25) + 0.30(10) + 0.30(-5) = 11.5%
Expected Return on ‘B’
(0.40 × 20) + (0.30 × 15) + 0.30 × (-8) = 10.1%
218
Expected Return on Market index

(0.40 × 18) + (0.30 × 13) + 0.30 × (-3) = 10.2%
Variance of Market index

(18 - 10.2)2 (0.40) + (13 - 10.2)2 (0.30) + (-3 - 10.2)2 (0.30)
= 24.34 + 2.35 + 52.27
= 78.96%
Covariance of stock A and Market Index M

Cov. (AM) = ∑ (ሾAi -EሺAሻሿሾMi -EሺMሻሿP
i = G, S, R
(25 -11.5) (18 - 10.2) (0.40) + (10 - 11.5) (13 - 10.2) (0.30) + (-5-11.5) (-3-10.2) (0.30)
= 42.12 + (-1.26) + 65.34
= 106.20
Covariance of stock B and Market index M

(20-10.1) (18-10.2) (0.40) + (15-10.1) (13-10.2) (0.30) + (-8-10.1) (-3-10.2) (0.30)
= 30.89 + 4.12 + 71.67
= 106.68
CoV(AM) 106.20
Beta for stock A = = = 1.345
VAR(M) 78.96
CoVሺBMሻ 106.68
Beta for stock B = = = 1.351
VAR (M) 78.96
Required Return for A

R (A) = Rf + β (M - Rf)
11% + 1.345(10.2 - 11) % = 9.924%
Required Return for B
11% + 1.351 (10.2 – 11) % = 9.92%
Alpha for Stock A

E (A) – R (A) i.e. 11.5 % – 9.924% = 1.576%
Alpha for Stock B
E (B) – R (B) i.e. 10.1% - 9.92% = 0.18%
Since stock A and B both have positive Alpha, therefore, they are UNDERPRICED. The
investor should make fresh investment in them.
219
Question 54
You are presented with the following information concerning the returns on the shares of C Ltd.
and on the market portfolio, according to the various conditions of the economy.
Condition of Prob. of Returns Returns
economy condition on C Ltd. on Market
1 0.2 15% 10%
2 0.4 14% 16%
3 0.4 26% 24%
The current risk free interest rate is 9%

Required:
(a) Calculate the coefficient of correlation between the returns on C ltd. and the market
portfolio.
(b) Calculate the total risk (i.e. standard deviation) of C Ltd. and discuss why this is not the
most appropriate measure of risk to be used in making investment decisions.
(c) Calculate the beta factor for C Ltd. and briefly discuss its significance. Is C Ltd. efficiently
priced according to the CAPM and the information given above?
Answer:
Prob. C M C×P M×P ¯ ¯ ¯ ¯ ¯ 2 ¯ 2
(C-C) (M-M) [(C-C)(M-M)] P (C-C) P (M-M) P
0.20 15 10 3 2 -4 -8 6.4 3.20 12.80

0.40 14 16 5.6 6.4 -5 -2 4 10.00 1.60
0.40 26 24 10.40 9.6 7 6 16.80 19.60 14.40
¯ ¯ 27.20 ¯2 ¯2
C = 19 M = 18 σc = 32.80 σm = 28.80
¯ ¯
σc = 5.73 σm = 5.37
a.
CovCM 27.20
RCM = = = 0.88
¯ ¯
σC σM 5.73 × 5.37
b. Total Risk C Ltd = 5.73%

This is not the best measure for taking investment decisions because it contains
unsystematic Risk which can be diversified & reduced to a greater extent & thus market
will not give any premium for this Risk.
The best measure is ß [Systematic Risk]
220
c.
¯
CovCM RCM × σC
Beta = or
σ2M σM
27.20 0.88 × 5.73
= 2
or
5.37 5.37
βC = 0.94 or 0.94
In order to calculate if the stock is efficiently priced. We need to compare Theoretical

Return [CAPM] & Expected Return [Incomplete in book]
∴ CAPM RC = Rf + β [Rm -Rf ]
= 9 + 0.94 [18 – 9]
= 17.46
Expected [19%] > CAPM [17.46]
∴ Shares are undervalued & its worth buying now.
Question 55
ABC Ltd. manufactures Car Air Conditioners (ACs), Window ACs and Split ACs constituting
60%, 25% and 15% of total market value. The stand-alone Standard Deviation and Coefficient
of Correlation with market return of Car AC and Window AC is as follows:
S.D. Coefficient of Correlation
Car AC 0.30 0.6
Window AC 0.35 0.7
No data for stand-alone SD and Coefficient of Correlation of Split AC is not available.

However, a company who derives its half value from Split AC and half from Window AC has
a SD of 0.50 and Coefficient of correlation with market return is 0.85. Index has a return of
10% and has SD of 0.20. Further, the risk-free rate of return is 4%.
(i) Beta of ABC Ltd.
(ii) Cost of Equity of ABC Ltd.
Assuming that ABC Ltd. wants to raise debt of an amount equal to half of its Market Value
then determine equity beta, if yield of debt is 5%.
MTP Oct 15 (8 Marks), RTP Nov 17
Answer:
221
σsm σs
(i) Determination of Beta of Car AC and Window AC =
σm
0.6 × 0.3
Car AC = = 0.90
0.2
0.7 × 0.35
Window AC = = 1.225
0.2
0.85 × 0.50
The Beta of Split AC/ Window AC is = = 2.125
0.2
The Beta of Split AC alone is
2.125 = 0.50 βs + 0.50 βw
= 0.50 βs + 0.50 × 1.225
βs = 3.025
ABC Ltd.’s Beta shall be:

0.6 × 0.9 + 0.25 × 1.225 + 0.15 × 3.025 = 1.30
(ii) Cost of Equity of ABC Ltd.

Ke = 4% + 1.30(10% - 4%) = 11.80%
(iii) Calculation of Debt Beta

5%-4%
= 0.167
10%-4%
Accordingly, Beta of Equity shall be
1.30 = 0.50 × 0.167 + 0.50 × βe
βe = 2.433
Question 56
Mr. FedUp wants to invest an amount of ₹520 lakhs and had approached his Portfolio Manager.
The Portfolio Manager had advised Mr. FedUp to invest in the following manner:
Security Moderate Better Good Very Good Best
Amount (in ₹ Lakhs) 60 80 100 120 160
Beta 0.5 1.00 0.80 1.20 1.50
You are required to advise Mr. FedUp in regard to the following, using Capital Asset Pricing
Methodology:
(i) Expected return on the portfolio, if the Government Securities are at 8% and the NIFTY is
yielding 10%.
222
(ii) Advisability of replacing Security 'Better' with NIFTY.
Nov 12 (8 Marks), MTP Sept 15 (6 Marks), MTP Aug 16 (8 Marks), MTP April 18 (New)
(7 Marks), RTP Nov 18 (New), StudyMat
Answer:
(i) Computation of Expected Return from Portfolio
Security Beta Expected Return (r) as per Amount Weights wr
(β) CAPM (₹ Lakhs) (w)
Moderate 0.50 8%+0.50(10% - 8%) = 9% 60 0.115 1.035
Better 1.00 8%+1.00(10% - 8%) = 10% 80 0.154 1.540
Good 0.80 8%+0.80(10% - 8%) = 9.60% 100 0.192 1.843
Very Good 1.20 8%+1.20(10% - 8%) = 10.40% 120 0.231 2.402
Best 1.50 8%+1.50(10% - 8%) = 11% 160 0.308 3.388
Total 520 1 10.208
Thus Expected Return from Portfolio 10.208% say 10.21%.

Alternatively, it can be computed as follows:
60 80 100 120 160
Average β = 0.50 × +1.00 × +0.80 × +1.20 × +1.50 × = 1.104
520 520 520 520 520
As per CAPM
= 0.08 + 1.104(0.10 – 0.08) = 0.10208 i.e. 10.208%
(ii) As computed above the expected return from Better is 10% same as from Nifty, hence
there will be no difference even if the replacement of security is made. The main logic
behind this neutrality is that the beta of security ‘Better’ is 1 which clearly indicates that
this security shall yield same return as market return.
Question 57
If the rate of return and Standard Deviation of Market Portfolio (Index) is 8% and 6%
respectively and the risk free rate of return is 5%, you are required to:
(i) Construct an efficient portfolio which produces expected return of 7.5%.
(ii) Calculate the risk of above portfolio.
(iii) Suppose if Mr. X has ₹1,00,000 of his personal funds, then how he would construct his
portfolio giving expected return of 10% and what will be risk of this portfolio.
MTP Mar 17 (8 Marks)
Answer:
223
(i) An efficient portfolio shall consist of the market portfolio and risk free securities.
Accordingly, let x be the proportion of total funds invested in market portfolio then
E (Rp) = x E(Rm) + (1 - x) Rf
7.5% = x × 8% + (1 – x) × 5%
7.5% = 8x + 5 – 5x
2.5 = 3x
x = 5/6 i.e. 83.33%
1
Thus, 83 %total funds should be invested in market portfolio and balance 16.67% in
3
Risk Free Securities.
(ii) Risk of above Portfolio

8%-5%
7.5 = 5.00+ σP
6%
3%
2.5 = σ
6% P
15% = 3%σP
σP = 5%
(iii) Let y be the proportion of investment in market portfolio then investment in risk free
securities (1 – y), then
10% = y × 8% + (1 - y) 5%
10% = 8y + 5% - 5y
5% = 3y
y = 1.66
2
Thus, borrow 66 % of owned fund i.e. 66.67% of owned funds at risk free rate of
3
interest of 5%.
₹100000 × 66.67 % = ₹66,670

Now invest total fund of ₹1,66,670 in the market portfolio.
Risk of Portfolio
8%-5%
10% = 5%+ σP
6%
3%
5% = σ
6% P
σP = 10%
224
Question 58
Suppose one of your HNI clients is holding the following portfolio as per his risk appetite:
Particulars Securities
Equity Shares:
G Ltd. 1000
S Ltd. 1000
B Ltd. 500
PSU Bonds 20,000
The other data related to each of these securities is as follows:

Cost Dividends/ Interest Market price Beta
₹ ₹ ₹
10,000 1,725 9,800 0.6
15,000 1,000 16,200 0.8
28,000 1400 28,300 0.6
1,800 180 1,725 0.10
Your client is interested in investing some more funds in Bonds issued by GOI.
(1) Estimate the minimum rate of return that your client would expect from these Bonds
keeping in view his risk appetite and assuming Market Return as 12.70%.
(2) Analyze whether this portfolio has out-performed the market or not assuming Risk Free
Rate of Return as 7%.
MTP Nov 21 (New) (8 Marks), MTP Nov 21 (Old) (8 Marks)
Answer:
(1) Working Notes:
Calculation of Return on each single security
Cost No. of Total Cost Dividend/ Capital Total Total Beta (6) x (3)
₹ Securities Interest gain Income (5) (6)
(2) (3) = (1) × (4)
= (2) × (4)
(1) (2)
G Ltd. 10,000 1000 1,00,00,000 1,725 -200 1,525 15,25,000 0.6 60,00,000
S Ltd. 15,000 1000 1,50,00,000 1,000 1,200 2,200 22,00,000 0.8 1,20,00,000
B Ltd. 28,000 500 1,40,00,000 1,400 300 1,700 8,50,000 0.6 84,00,000
PSU 1,800 20,000 3,60,00,000 180 -75 105 21,00,000 0.10 36,00,000
Bonds
Total 7,50,00,000 66,75,000 3,00,00,000
Rate of Return on earned on the Portfolio

Dividend Earned + Capital appreciation ₹66,75,000
×100 = ×100 = 8.90%
Initial investment ₹7,50,00,000
225
Weighted Average Beta of the Portfolio

3,00,00,000
=0.40
7,50,00,000
Expected Risk Free Rate of Return using CAPM

8.90% = Rf + 0.40[12.7% - Rf]
8.90% = Rf + 5.08 – 0.40 Rf
3.82% = 0.60 Rf
Rf = 6.37%
Thus keeping in view the present risk appetite, the client would expect at least a return of
6.37% on Bonds.
(2) The expected return on the Portfolio using CAPM:

= 7% + 0.40[12.7 – 7%] = 9.28%
Since the actual return is 8.90% which is quite lower than expected return considering
the systematic risk borne by the investor and hence portfolio has not outperformed the
market rather has underperformed.
Question 59
A Portfolio Manager (PM) has the following four stocks in his portfolio:
Security No. of Market Price β
Shares per share ( ₹)
VSL 10,000 50 0.9
CSL 5,000 20 1.0
SML 8,000 25 1.5
APL 2,000 200 1.2
Compute the following:

(i) Portfolio beta.
(ii) If the PM seeks to reduce the beta to 0.8, how much risk free investment should he bring
in?
(iii) If the PM seeks to increase the beta to 1.2, how much risk free investment should he bring
in?
RTP Nov 21 (New), RTP Nov 21 (Old), RTP Nov 16, Nov 11 (8 Marks), RTP May 20 (New), MTP Mar 17
(8 Marks), Practice Manual, StudyMat
Answer:
226
(i)
Security No. of Market Price of Per (1) × (2) % to β(x) wx
shares (1) Share (2) total (w)
VSL 10000 50 500000 0.4167 0.9 0.375
CSL 5000 20 100000 0.0833 1 0.083
SML 8000 25 200000 0.1667 1.5 0.250
APL 2000 200 400000 0.3333 1.2 0.400
1200000 1 1.108
Portfolio Beta 1.108

(ii)
Required Beta 0.8
It should become (0.8 / 1.108) 72.2 % of present portfolio
If ₹12,00,000 is 72.20%, the total portfolio should ₹16,62,050
be ₹12,00,000 × 100/72.20 or
Additional investment in zero risk should be (₹16,62,050 – ₹12,00,000) = ₹4,62,050
Revised Portfolio will be

Security No. of Market Price of (1) × (2) % to ß (x) wx
shares (1) Per Share (2) total (w)
VSL 10000 50 500000 0.3008 0.9 0.271
CSL 5000 20 100000 0.0602 1 0.060
SML 8000 25 200000 0.1203 1.5 0.180
APL 2000 200 400000 0.2407 1.2 0.289
Risk Free Asset 10 462500 0.2780 0 0
1662050 1 0.80
Revised Portfolio beta 0.80
(iii)
To increase Beta to 1.2
Required Beta 1.2
It should become (1.2 / 1.108) 108.30 % of present beta
If ₹12,00,000 is 108.30%, the total portfolio
should be ₹12,00,000 × 100/108.30 or 1108033 say 1108030
Additional investment should be (-) 91967 i.e. Divest ₹91970 of Risk Free Asset
227
Revised Portfolio will be

Security No. of Market Price of (1) × (2) % to ß (x) wx
shares (1) Per Share (2) total (w)
VSL 10000 50 500000 0.4513 0.9 0.406
CSL 5000 20 100000 0.0903 1 0.090
SML 8000 25 200000 0.1805 1.5 0.271
APL 2000 200 400000 0.3610 1.2 0.433
Risk Free Asset -9197 10 -91970 0.0830 0 0
1662050 1 1.20
Portfolio Beta 1.20
Alternative Approach
(i) Let x be the amount of Risk-Free Asset to be acquired, then
Security (1) × (2) Β(x) wx
VSL 500000 0.9 450000
CSL 100000 1 100000
SML 200000 1.5 300000
APL 400000 1.2 480000
Risk free asset x 0 0
120000 + x 1330000
Accordingly,
13,30,000
= 0.8
12,00,000+x
x = 462500 i.e. value of Risk Free Asset to be purchased to decrease beta of portfolio to
0.8.
(ii) Similarly let y the amount of Risk Free Assets to be divest, then
13,30,000
=1.20
12,00,000+y
y = -91,667 i.e. value of Risk Free Asset to be divested to increase beta of portfolio to
1.20.
228
Question 60
Ms. Preeti, a school teacher, after retirement has built up a portfolio of ₹1,20,000 which is as
follow:
Stock No. of shares Market price per share (₹) Beta
ABC Ltd. 1000 50 0.9
DEF Ltd. 500 20 1.0
GHI Ltd. 800 25 1.5
JKL Ltd. 200 200 1.2
Her portfolio consultant Sri Vijay has advised her to bring down the, beta to 0.8. You are required
to compute:
(i) Present portfolio beta
(ii) How much risk free investment should be bought in, to reduce the beta to 0.8?
MTP May 20 (New) (4 Marks), MTP May 19 (Old) (4 Marks), MTP March 21 (New) (6
Marks), MTP March 21 (Old) (6 Marks),
Answer:
Security No. of shares Market Price of Per Share (1) × (2) % to total ß(x) wx
(1) (2) (w)
ABC 1000 50 50000 0.4167 0.9 0.375
DEF 500 20 10000 0.0833 1 0.083
GHI 800 25 20000 0.1667 1.5 0.250
JKL 200 200 40000 0.3333 1.2 0.400
120000 1 1.108
Portfolio beta 1.108

Required Beta 0.8
It should become (0.8 / 1.108) 72.2 % of present portfolio
If ₹1,20,000 is 72.20%, the total portfolio should be ₹1,66,205
₹1,20,000 × 100/72.20 or
Additional investment in zero risk should be (₹1,66,205 – ₹1,20,000) = ₹46,205
229
Question 61
The returns of a portfolio A and market portfolio for the last 12 months are indicated as follows:
Month Portfolio A Market Portfolio
January - 0.52 0.82
February 2.20 0.04
March 2.17 2.80
April 4.17 1.72
May 2.04 0.27
June 3.00 0.39
July 1.99 1.95
August 4.00 0.64
September -1.38 1.53
October 2.67 2.70
November 3.99 2.52
December 1.86 2.09
Standard Deviation (σ) 1.6223 0.9498
(i) You are required to find out the monthly returns attributable to the sheer skill of the Portfolio
Manager.
(ii) What part of the monthly return is attributable to the higher risk assumed by the Portfolio
Manager?
Assume that the risk-free rate of return is 12% per annum and the portfolio is fully diversified.
Answer:
(i) The monthly risk free rate of return = (12%/12) = 1%
Month RA RM
January -0.52 0.82

February 2.20 0.04
March 2.17 2.80
April 4.17 1.72
May 2.04 0.27
June 3.00 0.39
July 1.99 1.95
230
August 4.00 0.64

September -1.38 1.53
October 2.67 2.70
November 3.99 2.52
December 1.86 2.09
26.19 17.47
Average Returns 2.1825 1.4558
(ii) Average Portfolio Return (Rp) = 2.1825

Average Market Return (Rm) = 1.4558
Portfolio Risk (σP) = 1.6223
Market Risk (σm) = 0.9498
Since portfolio A is fully diversified then it can be compared with a portfolio whose
beta (β) can be found as follows:
σm2 × β2 = σ2P
σP 1.6223
β= = = 1.708
σm 0.9498
Therefore, portfolio A is comparable to a portfolio whose Beta is 1.708.
Expected monthly returns on such portfolio can be calculated as follows:
R1P = Rf + β (Rm – Rf)
= 1% + 1.708 (1.4558% - 1.0000%)
= 1.7785%
Return due to the net selectivity = RP – R1P
= 2.1825% - 1.7785% = 0.404% per month
(ii) The returns due to higher risk assumed by the portfolio manager
= 1.7785% - 1.4558% = 0.3227% per month
Question 62
With the help of following data determine the return on the security X.
Factor Risk Premium associated with the Factor βi
Market 4% 1.3
Growth Rate of GDP 1% 0.3
Inflation -4% 0.2
Risk Free Rate of Return is 8%. StudyMat

231
Answer:
Expected Return = Rf + λ1 β1 + λ2 β2 + λ3 β3
= 8% + 1.3 × 4% + 0.3 × 1% + 0.2 × (-4%)
= 8% + 5.2% + 0.3% - 0.8%
= 12.7%
Question 63
Mr. Tamarind intends to invest in equity shares of a company the value of which depends
upon various parameters as mentioned below:
Factor Beta Expected value in% Actual value in %
GNP 1.20 7.70 7.70
Inflation 1.75 5.50 7.00
Interest rate 1.30 7.75 9.00
Stock market index 1.70 10.00 12.00
Industrial production 1.00 7.00 7.50
If the risk free rate of interest be 9.25%,

Calculate the return of the share under Arbitrage Pricing Theory?
May 11 (5 Marks), RTP May 13, RTP Nov 17, MTP Oct 18 (New) (6 Marks), Practice Manual, StudyMat
Answer:
Return of the stock under APT
Factor Actual Expected Difference Beta Diff. ×
value in % value in % Beta
GNP 7.70 7.70 0.00 1.20 0.00
Inflation 7.00 5.50 1.50 1.75 2.63
Interest rate 9.00 7.75 1.25 1.30 1.63
Stock index 12.00 10.00 2.00 1.70 3.40
Ind. Production 7.50 7.00 0.50 1.00 0.50
8.16
Risk free rate in % 9.25
Return under APT 17.41
232
Question 64
Assume that the following one-factor model describes the expected return for portfolios:
E(Rp) = 0.10 + 0.12 βp,1
Also assume that all investors agree on the expected returns and factor sensitivity of the three
highly diversified Portfolios A, B, and C given in the following table:
Portfolio Expected Return Factor Sensitivity
A 0.20 0.80
B 0.15 1.00
C 0.24 1.20
Assuming the one-factor model is correct and based on the data provided for Portfolios A, B,
and C, determine if an arbitrage opportunity exists and explain how it might be exploited.
Answer:
According to APT
Ri = 0.10 + 0.12ß
RA = 0.10 + 0.12 × 0.80 = 0.1960
RB = 0.10 + 0.12 × 1.00 = 0.22
RC = 0.10 + 0.12 × 1.20 = 0.2440
Security Expected Required Valuation Action
A 20% 19.60% Undervalued Buy
B 15% 22% Overvalued Sell
C 24% 24.40% Overvalued Sell
Question 65
Mr. Kapoor owns a portfolio with the following characteristics:
Security X Security Y Risk Free Security
Factor 1 sensitivity 0.75 1.50 0
Expected Return 15% 20% 10%
It is assumed that security returns are generated by a two factor model.
(i) If Mr. Kapoor has ₹1,00,000 to invest and sells short ₹50,000 of security Y and purchases
₹1,50,000 of security X, what is the sensitivity of Mr. Kapoor's portfolio to the two factors?
(ii) If Mr. Kapoor borrows ₹1,00,000 at the risk free rate and invests the amount, he borrows
along with the original amount of ₹1,00,000 in security X and Y in the same proportion as
described in part (i), what is the sensitivity of the portfolio to the two factors?
(iii) What is the expected return premium of factor 2?
233
June 09 (8 Marks), Nov 18 (New) (8 Marks), MTP March 21 (New) (12 Marks), Practice Manual
Answer:
(i) Mr. Kapoor’s position in the two securities is + 1.50 in security X and -0.5 in security Y.
Hence the portfolio sensitivities to the two factors:-
b prop. 1 = 1.50 × 0.75 + (-0.50 × 1.50) = 0.375
b prop. 2 = 1.50 × 0.60 + (-0.50 × 1.10) = 0.350
(ii) Mr. Kapoor’s current position:

Security X ₹ 300,000 / ₹1,00,000 = 3
Security Y - ₹1,00,000 / ₹1,00,000 = -1
Risk free asset - ₹100000/ ₹100000 = -1
b prop. 1 = 3.0 × 0.75 + (-1 × 1.50) + (- 1 × 0) = 0.75
b prop. 2 = 3.0 × 0.60 + (-1 × 1.10) + (-1 × 0) = 0.70
(iii) Expected Return = Risk Free Rate of Return + Risk Premium

Let λ1 and λ2 are the Value Factor 1 and Factor 2 respectively. Accordingly
15 = 10 + 0.75 λ1 + 0.60 λ2
20 = 10 + 1.50 λ1 + 1.10 λ2
On solving equation, the value of λ1 and λ2 comes 6.67 and 0 respectively.

Accordingly, the expected risk premium for the factor 2 shall be Zero and whatever be
the risk the same shall be on account of factor 1.
Alternatively, the risk premium of Securities X & Y can be calculated as follows:

Security X
Total Return = 15%
Risk Free Return = 10%
Risk Premium = 5%
Security Y
Total Return = 20%
Risk Free Return = 10%
Risk Premium = 10%
234
Question 66
Mr. X owns a portfolio with the following characteristics:
Security A Security B Risk Free security
Expected Return 15% 20% 10%
It is assumed that security returns are generated by a two factor model.

(i) If Mr. X has ₹1,00,000 to invest and sells short ₹50,000 of security B and purchases
₹1,50,000 of security A what is the sensitivity of Mr. X’s portfolio to the two factors?
(ii) If Mr. X borrows ₹1,00,000 at the risk free rate and invests the amount he borrows along
with the original amount of ₹1,00,000 in security A and B in the same proportion as
described in part (i), what is the sensitivity of the portfolio to the two factors?
(iii) What is the expected return premium of factor 2?
June 09 (8 Marks), StudyMat
Answer:
(i) Mr. X’s position in the two securities is + 1.50 in security A and -0.5 in security B.
Hence the portfolio sensitivities to the two factors:-
b prop. 1 = 1.50 × 0.80 + (-0.50 × 1.50) = 0.45
b prop. 2 = 1.50 × 0.60 + (-0.50 × 1.20) = 0.30
(ii) Mr. X’s current position:

Security A ₹300,000 / ₹1,00,000 = 3
Security B - ₹1,00,000 / ₹1,00,000 = -1
Risk free asset - ₹100000/ ₹100000 = -1
b prop. 1 = 3.0 × 0.80 + (-1 × 1.50) + (- 1 × 0) = 0.90
b prop. 2 = 3.0 × 0.60 + (-1 × 1.20) + (-1 × 0) = 0.60
(iii) Expected Return = Risk Free Rate of Return + Risk Premium

Let λ1 and λ2 are the Value Factor 1 and Factor 2 respectively.
Accordingly
15 = 10 + 0.80 λ1 + 0.60 λ2
20 = 10 + 1.50 λ1 + 1.20 λ2
On solving equation, the value of λ1 = 0, and risk premium of factor 2 for Securities A &
B shall be as follows:
235
Using Security A’s Return

Total Return = 15% = 10% + 0.60 λ2
Risk Premium (λ2) = 5%/0.60 = 8.33%
Alternatively using Security B’s Return

Total Return = 20% = 10 + 1.20 λ2
Risk Premium = 10%/1.20 = 8.33%
Question 67
An investor has two portfolios known to be on minimum variance set for a population of three
securities A, B and C having below mentioned weights:
WA WB WC
Portfolio X 0.30 0.40 0.30
Portfolio Y 0.20 0.50 0.30
It is supposed that there are no restrictions on short sales.

(i) What would be the weight for each stock for a portfolio constructed by investing ₹5,000 in
portfolio X and ₹3,000 in portfolio Y?
(ii) Suppose the investor invests ₹4,000 out of ₹8,000 in security A. How he will allocate the
balance between security B and C to ensure that his portfolio is on minimum variance set?
June 09 (6 Marks), Practice Manual
Answer:
(i) Investment committed to each security would be:-
A B C Total
(₹) (₹) (₹) (₹)
Portfolio X 1,500 2,000 1,500 5,000
Portfolio Y 600 1,500 900 3,000
Combined Portfolio 2,100 3,500 2,400 8,000
Stock weights 0.26 0.44 0.30
(ii) The equation of critical line takes the following form:-

WB = a + bWA
Substituting the values of WA & WB from portfolio X and Y in above equation, we get
0.40 = a + 0.30b, and
0.50 = a + 0.20b
236
Solving above equation we obtain the slope and intercept, a = 0.70 and b = -1 and thus,
the critical line is
WB = 0.70 – WA
If half of the funds is invested in security A then,

WB = 0.70 – 0.50 = 0.20
Since WA + WB + WC = 1
WC = 1 - 0.50 – 0.20 = 0.30
Allocation of funds to
Security B = 0.20 × 8,000 = ₹1,600, and
Security C = 0.30 × 8,000 = ₹2,400
Question 68
Mr. Nirmal Kumar has categorized all the available stock in the market into the following types:
(i) Small cap growth stocks
(ii) Small cap value stocks
(iii) Large cap growth stocks
(iv) Large cap value stocks
Mr. Nirmal Kumar also estimated the weights of the above categories of stocks in the market
index. Further, the sensitivity of returns on these categories of stocks to the three important
factors are estimated to be:
Category of Stocks Weight in the Factor I Factor II Factor III
Market Index (Beta) (Book Price) (Inflation)
Small cap growth 25% 0.80 1.39 1.35
Small cap value 10% 0.90 0.75 1.25
Large cap growth 50% 1.165 2.75 8.65
Large cap value 15% 0.85 2.05 6.75
Risk Premium 6.85% -3.5% 0.65%
The rate of return on treasury bonds is 4.5% Required:

(a) Using Arbitrage Pricing Theory, determine the expected return on the market index.
(b) Using Capital Asset Pricing Model (CAPM), determine the expected return on the market
index.
(c) Mr. Nirmal Kumar wants to construct a portfolio constituting only the ‘small cap value’ and
237
‘large cap growth’ stocks. If the target beta for the desired portfolio is 1, determine the
composition of his portfolio.
MTP April 22 (8 Marks), RTP Nov 19 (Old), Practice Manual
Answer:
(a) Method I
Stock’s return
Small cap growth = 4.5 + 0.80 × 6.85 + 1.39 × (-3.5) + 1.35 × 0.65 = 5.9925%
Small cap value = 4.5 + 0.90 × 6.85 + 0.75 × (-3.5) + 1.25 × 0.65 = 8.8525%
Large cap growth = 4.5 + 1.165 × 6.85 + 2.75 × (-3.5) + 8.65 × 0.65 = 8.478%
Large cap value = 4.5 + 0.85 × 6.85 + 2.05 × (-3.5) + 6.75 × 0.65 = 7.535%
Expected return on market index

0.25 × 5.9925 + 0.10 × 8.8525 + 0.50 × 8.478 + 0.15 × 7.535 = 7.7526%
Method II
Expected return on the market index
= 4.5% + [0.1 × 0.9 + 0.25 × 0.8 + 0.15 × 0.85 + 0.50 × 1.165] × 6.85 + [(0.75 ×
0.10 + 1.39 × 0.25 + 2.05 × 0.15 + 2.75 × 0.5)] × (-3.5) + [(1.25 × 0.10 + 1.35 ×
0.25 + 6.75 × 0.15 + 8.65 × 0.50)] × 0.65
= 4.5 + 6.85 + (-7.3675) + 3.77
= 7.7525%.
(b) Using CAPM,

Small cap growth = 4.5 + 6.85 × 0.80 = 9.98%
Small cap value = 4.5 + 6.85 × 0.90 = 10.665%
Large cap growth = 4.5 + 6.85 × 1.165 = 12.48%
Large cap value = 4.5 + 6.85 × 0.85 = 10.3225%
Expected return on market index

= 0.25 × 9.98 + 0.10 × 10.665 + 0.50 × 12.45 + 0.15 × 10.3225
= 11.33%
(c) Let us assume that Mr. Nirmal will invest X1% in small cap value stock and X2%
in large cap growth stock
X1 + X2 = 1
0.90 X1 + 1.165 X2 = 1
238
0.90 X1 + 1.165(1 – X1) = 1

0.90 X1+ 1 165 – 1.165 X1 = 1
0.165 = 0.265 X1
0.165
= X1
0.265
0.623 = X1, X2 = 0.377
62.3% in small cap value
37.7% in large cap growth.
Question 69
A has portfolio having following features:
Security β Random Error σei Weight
L 1.60 7 0.25
M 1.15 11 0.30
N 1.40 3 0.25
K 1.00 9 0.20
You are required to find out the risk of the portfolio if the standard deviation of the market index
(σm) is 18%.
MTP March 22 (8 Marks), May 12 (8 Marks), RTP Nov 16, MTP Oct 18 (Old) (5 Marks), Practice Manual
Answer:
4
βp = ∑ Xi βi
i=1
= 1.60 × 0.25 + 1.15 × 0.30 + 1.40 × 0.25 + 1.00 × 0.20
= 0.4 + 0.345 + 0.35 + 0.20
= 1.295
The Standard Deviation (Risk) of the portfolio is

= [(1.295)2(18)2 + (0.25)2(7)2 + (0.30)2(11)2 + (0.25)2(3)2 + (0.20)2(9)2]
= [543.36 + 3.0625 + 10.89 + 0.5625 + 3.24]
= [561.115]½
= 23.69%
Alternative Answer
The variance of Security’s Return = σ2 = βi2 σ2m + σ2εi
Accordingly, variance of various securities
239
σ2 Weight(w) σ2Xw
L (1.60)2 (18)2 + 72 = 878.44 0.25 219.61
M (1.15)2 (18)2 + 112 = 549.49 0.30 164.85
N (1.40)2 (18)2 + 32 = 644.04 0.25 161.01
K (1.00)2 (18)2 + 92 = 405.00 0.20 81
Variance 626.47
SD = √626.47 = 25.03%
Question 70
Following are the details of a portfolio consisting of 3 shares:
Shares Portfolio Weight Beta Expected Return (%) Total Variance
X Ltd. 0.3 0.50 15 0.020
Y Ltd. 0.5 0.60 16 0.010
Z Ltd. 0.2 1.20 20 0.120
Standard Deviation of Market Portfolio Return = 12%
(i) The Portfolio Beta.
(ii) Residual Variance of each of the three shares.
(iii) Portfolio Variance using Sharpe Index Model.
Answer:
(i) Portfolio Beta
= 0.30 × 0.50 + 0.50 × 0.60 + 0.20 × 1.20
= 0.15 + 0.3 + 0.24
= 0.69
(ii) Residual Variance

To determine Residual Variance first of all we shall compute the Systematic Risk as
follows:
2
βX × σ2M = ሺ0.5ሻ2 ሺ0.12ሻ2 = 0.0036
2
βY × σ2M = ሺ0.6ሻ2 ሺ0.12ሻ2 = 0.0052
2
βZ × σ2M = ሺ1.20ሻ2 ሺ0.12ሻ2 = 0.0207
240
Residual Variance = Total Variance – Systematic Risk
X 0.020 – 0.0036 = 0.0164

Y 0.010 – 0.0052 = 0.0048
Z 0.120 – 0.0207 = 0.0993
(iii) Portfolio variance using Sharpe Index Model

Portfolio Variance = Systematic Risk of the Portfolio + Unsystematic Risk of the Portfolio
Systematic Variance of Portfolio = (0.12)2 × (0.69)2 = 0.006856
Unsystematic Variance of Portfolio

= 0.0164 × (0.30)2 + 0.0048 × (0.50)2 + 0.0993 × (0.20)2 = 0.006648
Total Variance = 0.006856 + 0.006648 = 0.013504
Question 71
A study by a Mutual fund has revealed the following data in respect of three securities:
Security σሺ%ሻ Correlation with Index, Pm
A 20 0.60
B 18 0.95
C 12 0.75
The standard deviation of market portfolio (BSE Sensex) is observed to be 15%.
(i) What is the sensitivity of returns of each stock with respect to the market?
(ii) What are the co-variances among the various stocks?
(iii) What would be the risk of portfolio consisting of all the three stocks equally?
(iv) What is the beta of the portfolio consisting of equal investment in each stock?
(v) What is the total, systematic and unsystematic risk of the portfolio in (iv)?
Nov 09 (8 Marks), RTP Nov 15, MTP March 19 (Old) (8 Marks), RTP Nov 20 (New), RTP
Nov 20 (Old), Practice Manual
Answer:
(i) Sensitivity of each stock with market is given by its beta.
Standard deviation of market Index = 15%
Variance of market Index = 0.0225
Beta of stocks = σi r/σm
A = 20 × 0.60/15 = 0.80
B = 18 × 0.95/15 = 1.14
C = 12 × 0.75/15 = 0.60
241
(ii) Covariance between any 2 stocks = β1 β2 σ2m

Covariance matrix
Stock/Beta 0.80 1.14 0.60
A 400.000 205.200 108.000
B 205.200 324.000 153.900
C 108.00 153.900 144.000
(iii) Total risk of the equally weighted portfolio (Variance)

= 400(1/3)2 + 324(1/3)2 + 144(1/3)2 + 2(205.20) (1/3)2 + 2(108.0) (1/3)2 + 2(153.900)
(1/3)2
= 200.244
(iv) β of equally weighted portfolio

∑βi 0.80+1.14+0.60
βp = = = 0.8467
N 3
2
(v) Systematic Risk βp σm 2 = (0.8467)2(15)2 = 161.302
(vi) Unsystematic Risk = Total Risk – Systematic Risk

= 200.244 – 161.302
= 38.942
Question 72
Following are risk and return estimates for two stocks
Stock Expected returns (%) Beta Specific SD of expected return (%)
A 14 0.8 35
B 18 1.2 45
The market index has a Standard Deviation (SD) of 25% and risk free rate on Treasury Bills is
6%.
(i) The standard deviation of expected returns on A and B.
(ii) Suppose a portfolio is to be constructed with the proportions of 25%, 40% and 35% in
stock A, B and Treasury Bills respectively, what would be the expected return, standard
deviation of expected return of the portfolio?
242
Answer:
(i) Total Risk = Systematic Risk + Unsystematic Risk
Stock A
Systematic Risk = β2 σ2m = (0.8)2 × (25)2 = 400
Unsystematic Risk = 352
2
Total Risk = σ = √400+(35) = ඥ1625 = 40.31%
Stock B
Systematic Risk = β2 σ2m = (1.2)2 × (25)2 = 900
Unsystematic Risk = 452
2
Total Risk = σ = √900+(45) = √2925 = 54.08%
(ii) Expected return of the portfolio

(0.25 × 14) + (0.40 × 18) + (0.35 × 6) = 12.8%
Total Risk = Systematic Risk + Unsystematic Risk

Systematic Risk βp2σ2m
βp = 0.25 (0.8) + 0.4 (1.2) + 0.35 (0) = 0.2 + 0.48 + 0 = 0.68
Systematic Risk of Portfolio
2 2
= √(0.68) × (25)
= ඥ289
Non-systematic Risk of Portfolio

2 2 2 2
= (0.25) (35) +(0.40) (45) +0
= 76.56+324
= ඥ400.56
Total Risk = √289+400.56 = 26.26%
243
Question 73
Following are the details of a portfolio consisting of three shares:
Share Portfolio weight Beta Expected return in % Total Variance
DGS 0.35 0.30 12% 0.010
DV 0.25 1.20 18% 0.030
BP 0.40 0.50 10% 0.015
Standard Deviation of Market Portfolio Returns = 14%

Covariance (DGS, DV) = 0.020,
Covariance (DV, BP) = 0.050,
Covariance (BP, DGS) = 0.030
(i) The Portfolio Beta
(ii) Residual Variance of each of the three Shares,
(iii) Portfolio Variance using Sharpe Index Model,
(iv) Portfolio Variance (on the basis of Modern Portfolio Theory given by Markowitz).
Jan 21 (8 Marks), May 15 (8 Marks), MTP Oct 17 (10 Marks), MTP April 18 (8 Marks), MTP Aug 18
(10 Marks), MTP Nov 21 8 Marks, RTP May 18, Practice Manual
Answer:
(i) Portfolio Beta
0.35 × 0.30 + 0.25 × 1.20 + 0.40 × 0.50 = 0.605
(ii) Residual Variance

To determine Residual Variance first of all we shall compute the Systematic Risk as
follows:
β2A × σ2M = (0.30)2(0.14)2 = 0.001764
β2B × σ2M = (1.20)2(0.14)2 = 0.028224
β2C × σ2M = (0.50)2(0.14)2 = 0.0049
Residual Variance
DGS 0.010 – 0.001764 = 0.008236
DV 0.030 – 0.028224 = 0.001776
BP 0.015 – 0.0049 = 0.0101
(iii) Portfolio variance using Sharpe Index Model

Systematic Variance of Portfolio = (0.14)2 × (0.605)2 = 0.007174 or 0.0072
Unsystematic Variance of Portfolio = 0.008236 × (0.35)2 + 0.001776 × (0.25)2 +
0.0101 × (0.40)2 = 0.002736 or 0.0027
Total Variance = 0.007174 + 0.002736 = 0.00991 or 0.0099
244
(iv) Portfolio variance on the basis of Markowitz Theory

= (wA × wA× σ 2
A) + (wA × wB × CovAB) + (wA × wC × CovAC) + (wB × wA × CovAB) +
(wB × wB × σ 2B ) + (wB × wC × CovBC) + (wC × wA × CovCA) + (wC × wB × CovCB) +
(wC × wC × σ 2C)
= (0.35 × 0.35 × 0.010) + (0.35 × 0.25 × 0.020) + (0.25 × 0.40 × 0.050) + (0.40 × 0.35
× 0.030) + (0.25 × 0.35 × 0.020) + (0.40 × 0.25 × 0.050) + (0.35 × 0.40 × 0.030) +
(0.25 × 0.25 × 0.030) + (0.40 × 0.40 × 0.015)
= 0.001225 + 0.00175 + 0.005 + 0.0042 + 0.00175 + 0.005 + 0.0042 + 0.001875+
0.0024
= 0.0274
Question 74
The expected return of the market portfolio is 14% and the risk free rate is 10%. The standard
deviation of the market portfolio is 28% whereas the standard deviation of the portfolio of an
investor is 37%. Find out the expected return of the investor as per CML
Answer:
σi
CML = Ri = Rf + ሾR -R ሿ
σm m f
37
= 10+ ሾ14-10ሿ
28
= 15.29%
Question 75
Assuming that shares of ABC Ltd. and XYZ Ltd. are correctly priced according to Capital Asset
Pricing Model. The expected return from and Beta of these shares are as follows:
Share Beta Expected return
ABC 1.2 19.8%
XYZ 0.9 17.1%
You are required to derive Security Market Line.

RTP Nov 11, Practice Manual
Answer:
CAPM = Rf + β (Rm –Rf)
Accordingly
RABC = Rf + 1.2 (Rm –Rf) = 19.8
RXYZ = Rf + 0.9 (Rm –Rf) = 17.1
19.8 = Rf + 1.2 (Rm –Rf) (1)
17.1 = Rf + 0.9 (Rm –Rf) (2)
245
Deduct (2) from (1)

2.7 = 0.3 (Rm – Rf)
Rm – Rf = 9
Rf = Rm – 9
Substituting in equation (1)

19.8 = (Rm – 9) + 1.2 (Rm – Rm + 9)
19.8 = Rm - 9 + 10.8
19.8 = Rm + 1.8
Then, Rm = 18% and Rf = 9%
Security Market Line = Rf + β (Market Risk Premium) = 9% + β × 9%
Question 76
Assuming that two securities X and Y are correctly priced on SML and expected return from
these securities are 9.40% (Rx) and 13.40% (Ry) respectively. The Beta of these securities
are 0.80 and 1.30 respectively.
Mr. A, an investment manager states that the return on market index is 9%.
You are required to determine,
(i) Whether the claim of Mr. A is right. If not, then what is correct return on market index.
(ii) Risk Free Rate of Return.
RTP May 12
Answer:
Since security market line is graphical present of CAPM. Accordingly,
Rp = Rf + βp (Rm – Rf)
Where, Rp = Return from particular security
βp = Beta of security
Rm = Market Return
Rf = Risk free Rate of Return
Thus, Rx = 9.40 = Rf + 0.80 (Rm – Rf) (1)

and
Ry = 13.40 = Rf + 1.30 (Rm – Rf) (2)
Solving equation (1) & (2) we can find
Rf = 3% and Rm = 11%
(i) Thus, claim of Mr. A is not correct. The correct rate is 11%.
(ii) Risk Free Rate of Return is 3%
246
Question 77
Expected returns on two stocks for particular market returns are given in the following table:
Market Return Aggressive Defensive
7% 4% 9%
25% 40% 18%

(i) The Betas of the two stocks.
(ii) Expected return of each stock, if the market return is equally likely to be 7% or 25%.
(iii) The Security Market Line (SML), if the risk free rate is 7.5% and market return is equally
likely to be 7% or 25%.
(iv) The Alphas of the two stocks.
RTP May 14, MTP March 15 (8 Marks), RTP May 18 , MTP Aug 18 (8 Marks), RTP May 19, MTP Oct
19 (8 Marks), MTP May 20 (5 Marks), Practice Manual
Answer:
(i) The Betas of two stocks:
Aggressive stock - 40% - 4%/25% - 7% = 2
Defensive stock - 18% - 9%/25% - 7% = 0.50
Alternatively, it can also be solved by using the Characteristic Line Relationship as

follows:
Rs = α + βRm
Where
α = Alpha, β = Beta, Rm = Market Return
For Aggressive Stock

4% = α + β (7%)
40% = α + β (25%)
36% = β (18%)
β=2
For Defensive Stock

9% = α + β (7%)
18% = α + β (25%)
9% = β (18%)
β = 0.50
247
(ii) Expected returns of the two stocks:

Aggressive stock - 0.5 × 4% + 0.5 × 40% = 22%
Defensive stock - 0.5 × 9% + 0.5 × 18% = 13.5%
(iii) Expected return of market portfolio = 0.5 × 7% + 0.5% × 25% = 16%

∴ Market risk prem. = 16% - 7.5% = 8.5%
∴ SML is, required return = 7.5% + βi 8.5%
(iv) Rs = α + βRm
For Aggressive Stock
22% = αA + 2(16%)
αA = -10%
For Defensive Stock

13.5% = αD + 0.50(16%)
αD = 5.5%
Question 78
Following are the security returns and market returns for last 10 months
Security Return (X) Market Return (Y)
1 4.6 3.2
2 -0.5 0.3
3 3.3 3.8
4 3.9 3.5
5 -2.3 -1.6
6 4.5 4.1
7 4.6 4.0
8 4.3 4.4
9 4.1 6.0
10 -3.6 -2.7
Estimate the values of α & β for the security

Answer:
248
X Y XY Y2
4.6 3.3 15.18 10.89
-0.5 0.3 -0.15 0.09
3.3 3.8 12.54 14.44
3.9 3.5 13.65 12.25
-2.3 -1.6 3.68 2.56
4.5 4.1 18.45 16.81
4.6 4.0 18.40 16.00
4.3 4.4 18.92 19.36
4.1 6.0 24.60 36
-3.6 -2.7 9.72 7.29
¯ ¯ 135.00 135.69
X = 2.29 Y = 2.51
According to Regression Analysis:

¯
∑xy-nxy 135-10 × 2.29 × 2.51 77.52
βi = = = = 1.066
¯2 135.69-10 × ሺ2.51ሻ2 72.69
∑y2 -ny
According to SIM/SCL
Ri = αi +βi Rm
Rx = αx +βx Rm
2.29 = αx + 1.066 × 2.51
αx = -0.39
Question 79
The rates of return on the security of Company X and market portfolio for 10 periods are given
below:
Period Return of Security X (%) Return on Market Portfolio (%)
1 20 22
2 22 20
3 25 18
4 21 16
5 18 20
6 -5 8
249
7 17 -6
8 19 5
9 -7 6
10 20 11
(i) What is the beta of Security X?

(ii) What is the characteristic line for Security X?
RTP Nov 13, RTP May 15, Practice Manual, StudyMat
Answer:
(i)
Period RX RM RX -RX RM -RM 2
(RX -RX )(RM -RM ) (RM -RM )
1 20 22 5 10 50 100
2 22 20 7 8 56 64
3 25 18 10 6 60 36
4 21 16 6 4 24 16
5 18 20 3 8 24 64
6 -5 8 -20 -4 80 16
7 17 -6 2 -18 -36 324
8 19 5 4 -7 -28 49
9 -7 6 -22 -6 132 36
10 20 11 5 -1 -5 1
150 120 357 706
ΣRX ΣRM ¯ ¯ ¯
2
Σ(RX -RX )(RM -RM ) Σ(RM -RM )
RX = 15RM = 12
2
Σ൫RM -R M ൯ 706
σ2 M = = = 70.60
n 10
Σ൫RX -R X ൯(RM -R M ) 357
CovXM = = = 35.70
n 10
CovXM 35.70
BetaX = = = 0.505
σ2 M 70.60
250
Alternative Solution
Period X Y Y2 XY
1 20 22 484 440
2 22 20 400 440
3 25 18 342 450
4 21 16 256 336
5 18 20 400 360
6 -5 8 64 -40
7 17 -6 36 -102
8 19 5 25 95
9 -7 6 36 -42
10 20 11 121 220
150 120 2146 2157
̅ = 15 Y
X ̅ = 12
̅Y
XY-nX ̅ 2157 -10 × 15 × 12 357
BetaX = 2
= = = 0.506
∑ X2 -n൫X
̅൯ 2146 -10 × 12 × 12 706
¯ ¯
(ii) RX = 15, RM = 12
y = α + βX Rm
15 = α + 0.505 × 12
Alpha (α) = 15 – (0.505 × 12) = 8.94%
Characteristic line for security X = α + β × RM
Where, RM = Expected return on Market Index
∴ Characteristic line for security X = 8.94 + 0.505 RM
Question 80
The returns and market portfolio for a period of four years are as under:
Year % Return of Stock B % Return on Market Portfolio
1 10 8
2 12 10
3 9 9
4 3 -1
251
For stock B, you are required to determine:

(i) Characteristic line; and
(ii) The Systematic and Unsystematic risk.
June 09 (6 Marks), Nov 16 (8 Marks), Practice Manual
Answer:
Characteristic line is given by
αi +βi Rm
¯ ¯
∑xy- nxy
βi = 2
∑x2 -n(x)
¯ ¯
αi = y- βx
Return on Return on XY X2 ¯ ¯ 2 ¯ ¯ 2
(x-x) (x-x) (y-y) (y-y)
B(Y) Market (X)
10 8 80 64 1.50 2.25 1.50 2.25
12 10 120 100 3.50 12.25 3.50 12.25
9 9 81 81 2.50 6.25 0.50 0.25
3 -1 -3 1 -7.50 56.25 -5.50 30.25
34 26 278 246 77.00 45.00
¯ 34 ¯ 26
y= = 8.50, x = = 6.50
4 4
¯ ¯
∑xy- nxy 278-4(6.50)(8.50) 278-221 57
β= 2
= 2
= = = 0.74
∑x2 -n(x) 246-4(6.50) 246-169 77
¯ ¯
α = y-βx = 8.50-0.74ሺ6.50ሻ = 3.69
Hence the characteristic line is 3.69 + 0.74 (Rm)

¯ 2
∑(x-x) 77
Total Risk of Market = σm2 = = = 19.25(%)
n 4
45
Total Risk of Stock = = 11.25(%)
4
2
Systematic Risk = βi σ2m = ሺ0.74ሻ2 × 19.25 = 10.54ሺ%ሻ
Unsystematic Risk is = Total Risk – Systematic Risk = 11.25 – 10.54 = 0.71(%)
252
Question 81
The returns on stock A and market portfolio for a period of 6 years are as follows:
Year Return on A Return on market
(%) portfolio (%)
1 12 8
2 15 12
3 11 11
4 2 -4
5 10 9.5
6 -12 -2

(i) Characteristic line for stock A
(ii) The systematic and unsystematic risk of stock A.
June 09 (8 Marks), StudyMat
Answer:
Characteristic line is given by
αi +βi Rm
¯¯
∑xy- nxy
βi = 2
¯
∑x2 -n(x)
¯ ¯
αi = y- βx
Return on Return on xy x2 ¯ ¯ 2 ¯ ¯ 2
(x-x) (x-x) (y-y) (y-y)
A(Y) Market (X)
12 8 96 64 2.25 5.06 5.67 32.15
15 12 180 144 6.25 39.06 8.67 75.17
11 11 121 121 5.25 27.56 4.67 21.81
2 -4 -8 16 -9.75 95.06 -4.33 18.75
10 9.5 95 90.25 3.75 14.06 3.67 13.47
-12 -2 24 4 -7.75 60.06 -18.33 335.99
38 34.5 508 439.25 240.86 497.34
¯ 38 ¯ 34.5
y= = 6.33, x = = 5.75
6 6
253
¯ ¯
∑xy- nxy 508-6(5.75)(6.33) 508-218.385 289.615
β= = = = = 1.202
¯ 2 439.25-6(5.75)
2 439.25-198.375 240.875
∑x2 -n(𝐱)
¯ ¯
α = y-βx = 6.33-1.202ሺ5.75ሻ = -0.58
Hence the characteristic line is -0.58 + 1.202 (Rm)

¯ 2
∑(x-x) 240.86
Total Risk of Market = σm2 = = = 40.14(%)
n 6
497.34
Total Risk of Stock = = 82.89(%)
6
2
Systematic Risk = βi σ2m = ሺ1.202ሻ2 × 40.14 = 57.99ሺ%ሻ
Unsystematic Risk is = Total Risk – Systematic Risk

= 82.89 – 57.99
= 24.90(%)
Question 82
The following are the data on five mutual funds:
Fund Return Standard Deviation Beta
A 15 7 1.25
B 18 10 0.75
C 14 5 1.40
D 12 6 0.98
E 16 9 1.50
You are required to compute Reward to Volatility Ratio and rank these portfolio using:
• Sharpe method and
• Treynor’s method
Assuming the risk free rate is 6%.
May 16 (5 Marks), RTP Nov 17, RTP Nov 18 (New), RTP May 19 (Old), MTP OCT 20 (New) (8 Marks), MTP
Oct 20 (Old) (6 Marks), Practice Manual, StudyMat
Answer:
Sharpe Ratio S = (Rp – Rf)/σp
Treynor Ratio T = (Rp – Rf)/βp
Where,
Rp = Return on Fund
254
Rf = Risk-free rate
σp = Standard deviation of fund
Βp = Beta of Fund
Reward to Variability (Sharpe Ratio)

Mutual Fund Rp Rf Rp – Rf σp Reward to Variability Ranking
A 15 6 9 7 1.285 2
B 18 6 12 10 1.20 3
C 14 6 8 5 1.60 1
D 12 6 6 6 1.00 5
E 16 6 10 9 1.11 4
Reward to Volatility (Treynor Ratio)
Mutual Fund Rp Rf Rp – Rf βp Reward to Volatility Ranking
A 15 6 9 1.25 7.2 2
B 18 6 12 0.75 16 1
C 14 6 8 1.40 5.71 5
D 12 6 6 0.98 6.12 4
E 16 6 10 1.50 6.67 3
Question 83
The five portfolios of a mutual fund experienced following result during last 10 years periods:
Portfolio Average annual Standard Correlation with the
return % Deviation market return
A 20.0 2.3 0.8869
B 17.0 1.8 0.6667
C 18.0 1.6 0.600
D 16.0 1.8 0.867
E 13.5 1.9 0.5437
Market risk : 1.2

Market rate of return : 14.3%
255
Risk free rate : 10.1%

Beta may be calculated only up to two decimals. Rank the
portfolio using JENSEN'S ALPHA method.
May 17 (8 Marks)
Answer:
Let portfolio standard deviation be σp
Market Standard Deviation = σm
Coefficient of correlation = r
σpr
Portfolio beta ቀβp ቁ = ,(Beta for A = 2.30 × 0.8869/1.2 = 1.7,etc)
σm
Required portfolio return (Rp) = Rf + βp (Rm – Rf),

[ Rp for A = 10.1 +1.70 × (14.3-10.1) = 17.24, etc.]
Portfolio Beta Return from the portfolio (Rp) (%)
A 1.70 17.24
B 1.00 14.30
C 0.80 13.46
D 1.30 15.56
E 0.86 13.71
Portfolio Actual Return Expected Return Jensen's Alpha

% % AR – ER Rank
A 20 17.24 2.76 II
B 17 14.30 2.70 III
C 18 13.46 4.54 I
D 16 15.56 0.44 IV
E 13.5 13.71 -0.21 V
256
Question 84
Five portfolios experienced the following results during a 7- year period:
Portfolio Average Annual Standard Correlation with the
Return (Rp) (%) Deviation (Sp) market returns (r)
A 19.0 2.5 0.840
B 15.0 2.0 0.540
C 15.0 0.8 0.975
D 17.5 2.0 0.750
E 17.1 1.8 0.600
Market Risk (σm) 1.2
Market rate of Return (Rm) 14.0
Risk-free Rate (Rf) 9.0
Rank the portfolios using (a) Sharpe’s method, (b) Treynor’s method and (c) Jensen’s Alpha
RTP Nov 21(New), RTP Nov 21(Old), MTP Oct 19 (Old) (8 Marks), Practice Manual
Answer:
Let portfolio standard deviation be σp
Market Standard Deviation = σm
Coefficient of correlation = r
Portfolio beta (βp) = σp r
σm
Required portfolio return (Rp) = Rf + βp (Rm – Rf)

Portfolio Beta Return from the portfolio (Rp)(%)
A 1.75 17.75
B 0.90 13.50
C 0.65 12.25
D 1.25 15.25
E 0.90 13.50
Portfolio Sharpe Method Treynor Method Jensen's Alpha

Ratio Rank Ratio Rank Ratio Rank
A 4.00 IV 5.71 V 1.25 V
B 3.00 V 6.67 IV 1.50 IV
257
C 7.50 I 9.23 I 2.75 II

D 4.25 III 6.80 III 2.25 III
E 4.50 II 9.00 II 3.60 I
Question 85
The following are the details of three mutual funds of MFL:
Growth Balanced Regular Market
Fund Fund Fund
Average Return (%) 7 6 5 9
Variance 92.16 54.76 40.96 57.76
Coefficient of Determination 0.3025 0.6561 0.9604
The yield on 182 days Treasury Bill is 9 per cent per annum. You are required to:
(i) Rank the funds as per Sharpe's measure.
(ii) Rank the funds as per Treynor's measure.
(iii) Compare the performance with the market.
Answer:
Growth Fund Balanced Fund Regular Fund Market
Average Return (%) 7 6 5 9
Variance 92.16 54.76 40.96 57.76
Std. Deviation 9.60 7.40 6.40 7.60
Coefficient of 0.3025 0.6561 0.9604
Determination
Coefficient of 0.55 0.81 0.98
Correlation
Beta (β) 9.60 7.40 6.40
× 0.55 = 0.695 × 0.81 = 0.789 × 0.98 = 0.825
7.60 7.60 7.60
(i) Ranking of Funds as per Sharpe Ratio

Expected Return-Risk Free Rate of Return
Sharpe Ratio =
Standard Deviation
Growth Fund Balanced Fund Regular Fund
Sharpe Ratio 7-9 6-9 5-9
= -0.208 = -0.405 = -0.625
9.60 7.40 6.40
Ranking 1 2 3
258
(ii) Ranking of Funds as per Treynor Ratio

Treynor Ratio =
Beta
Growth Fund Balanced Fund Regular Fund

Treynor Ratio 7-9 6-9 5-9
= -2.878 = -3.802 = -4.84
0.695 0.789 0.825
Ranking 1 2 3
(iii) Comparison of performance with the Market

Sharpe Ratio 9-9
=0
7.60
Treynor Ratio 9-9
=0
1
Thus, the performance of funds is very poor since all values are negative as compared
to market performance.
Question 86
Mr. Abhishek is interested in investing ₹2,00,000 for which he is considering following three
alternatives:
(i) Invest ₹2,00,000 in Mutual Fund X (MFX)
(ii) Invest ₹2,00,000 in Mutual Fund Y (MFY)
(iii) Invest ₹1,20,000 in Mutual Fund X (MFX) and ₹80,000 in Mutual Fund Y (MFY)
Average annual return earned by MFX and MFY is 15% and 14% respectively. Risk free rate of
return is 10% and market rate of return is 12%.
Covariance of returns of MFX, MFY and market portfolio Mix are as follow:
MFX MFY Mix
MFX 4.800 4.300 3.370
MFY 4.300 4.250 2.800
M 3.370 2.800 3.100
(i) Variance of return from MFX, MFY and market return,
(ii) Portfolio return, beta, portfolio variance and portfolio standard deviation,
(iii) Expected return, systematic risk and unsystematic risk; and
(iv) Sharpe ratio, Treynor ratio and Alpha of MFX, MFY and Portfolio Mix
Nov 16 (8 Marks), MTP Mar 19 (New) (12 Marks), RTP Nov 20 (New), RTP Nov 20
(Old), Practice Manual, StudyMat
259
Answer:
(i) Variance of Returns
Cov(i,j)
Cori,j =
σi σj
Accordingly, for MFX
Cov(X,X)
1=
σX σX
σ2X = 4.800
Accordingly, for MFY

Cov(Y,Y)
1=
σY σY
σ2Y = 4.250
Accordingly, for Market Return

Cov(M,M)
1=
σM σM
σ2M = 3.100
Alternatively, by referring diagonally the given Table these values can identified as
follows:
VarianceX = 4.800
VarianceY = 4.250
VarianceX = 3.100
(ii) Portfolio return, beta, variance and standard deviation

1,20,000
Weight of MFX in portfolio = = 0.60
2,00,000
80,000
Weight of MFY in portfolio = = 0.40
2,00,000
Accordingly, Portfolio Return
0.60 × 15% + 0.40 × 14% = 14.60%
Beta of each Fund

Cov (Fund, Market)
β=
Variance of Market
3.370
βX = = 1.087
3.100
260
2.800
βY = = 0.903
3.100
Portfolio Beta
0.60 × 1.087 + 0.40 × 0.903 = 1.013
Portfolio Variance
σ2XY = W2X σ2X +W2Y σ2Y +2WX WY CovX,Y
= ሺ0.60ሻ2 ሺ4.800ሻ+ሺ0.40ሻ2 ሺ4.250ሻ+2ሺ0.60ሻሺ0.40ሻሺ4.300ሻ = 4.472%
Or Portfolio Standard Deviation
σXY = √4.472 = 2.115%
(iii) Expected Return, Systematic and Unsystematic Risk of Portfolio

Portfolio Return = 10% + 1.0134(12% - 10%) = 12.03%
MF X Return = 10% + 1.087(12% - 10%) = 12.17%
MF Y Return = 10% + 0.903(12% - 10%) = 11.81%
2
Systematic Risk = β σ2
Accordingly,
Systematic Risk of MFX = (1.087)2 × 3.10 = 3.663
Systematic Risk of MFY = (0.903)2 × 3.10 = 2.528
Systematic Risk of Portfolio = (1.013)2 × 3.10 = 3.181
Unsystematic Risk = Total Risk – Systematic Risk

Accordingly,
Unsystematic Risk of MFX = 4.80 – 3.663 = 1.137
Unsystematic Risk of MFY = 4.250 – 2.528 = 1.722
Unsystematic Risk of Portfolio = 4.472 – 3.181 = 1.291
(iv) Sharpe and Treynor Ratios and Alpha

Sharpe Ratio
15%-10%
MFX = = 2.282
√4.800
14%-10%
MFY = = 1.94
√4.250
14.6%-10%
Portfolio = = 2.175
2.115
261
Treynor Ratio
15%-10%
MFX = = 4.60
1.087
14%-10%
MFY = = 4.43
0.903
14.6%-10%
Portfolio = = 4.54
1.0134
Alpha
MFX = 15% - 12.17% = 2.83%
MFY = 14% - 11.81% = 2.19%
Portfolio = 14.6% - 12.03% = 2.57%
Question 87
Suppose that economy A is growing rapidly and you are managing a global equity fund that has
so far invested only in developed-country stocks. Now you have decided to add stocks of
economy A to your portfolio. The table below shows the expected rates of return, standard
deviations, and correlation coefficients (all estimated for the aggregate stock market of
developed countries and stock market of Economy A).
Developed country Stocks of
stocks Economy A
Expected rate of return (annualized percent) 10 15
Risk [Annualized Standard Deviation (%)] 16 30
Correlation Coefficient (ρ) 0.30
Assuming the risk-free interest rate to be 3%, you are required to determine:
(a) What percentage of your portfolio should you allocate to stocks of Economy A if you want
to increase the expected rate of return on your portfolio by 0.5%?
(b) What will be the standard deviation of your portfolio assuming that stocks of Economy A
are included in the portfolio as calculated above?
(c) Also show how well the Fund will be compensated for the risk undertaken due to inclusion
of stocks of Economy A in the portfolio?
RTP Nov 12, MTP Feb 16 (8 Marks), Practice Manual
262
Answer:
(a) Let the weight of stocks of Economy A is expressed as w, then
(1- w) × 10.0 + w × 15.0 = 10.5
i.e. w = 0.1 or 10%.
(b) Variance of portfolio shall be:

(0.9)2 (0.16)2 + (0.1)2 (0.30)2 + 2(0.9) (0.1) (0.16) (0.30) (0.30) = 0.02423
Standard deviation is (0.02423)½ = 0.15565 or 15.6%.
(c) The Sharpe ratio will improve by approximately 0.044, as shown below:
Sharpe Ratio =
Standard Deviation
10-3
Investment only in developed countries: = 0.437
16
10.5-3
With inclusion of stocks of Economy A: = 0.481
15.6
Question 88
Ramesh wants to invest in stock market. He has got the following information about individual
securities:
Security Expected Return Beta σ2 ci
A 15 1.5 40
B 12 2 20
C 10 2.5 30
D 09 1 10
E 08 1.2 20
F 14 1.5 30
Market index variance is 10 percent and the risk free rate of return is 7%. What should be the
optimum portfolio assuming no short sales?
MTP Mar 16 (6 Marks), Practice Manual
Answer:
Securities need to be ranked on the basis of excess return to beta ratio from highest to the
lowest.
263
Security Ri βi Ri -Rf Ri -Rf

βi
A 15 1.5 8 5.33
B 12 2 5 2.5
C 10 2.5 3 1.2
D 9 1 2 2
E 8 1.2 1 0.83
F 14 1.5 7 4.67
Ranked Table
Security Ri -Rf βi σ2ei (Ri -Rf )βi N
(Ri -Rf )βi βi
2 N
βi
2 Ci
σ2ei ∑ ∑
σ2ei σ2ei σ2ei
e=i e=i
A 8 1.5 40 0.30 0.30 0.056 0.056 1.923

F 7 1.5 30 0.35 0.65 0.075 0.131 2.814
B 5 2 20 0.50 1.15 0.20 0.331 2.668
D 2 1 10 0.20 1.35 0.10 0.431 2.542
C 3 2.5 30 0.25 1.60 0.208 0.639 2.165
E 1 1.2 20 0.06 1.66 0.072 0.711 2.047
CA = 10 × 0.30 / [1 + (10 × 0.056)] = 1.923
CF = 10 × 0.65 / [1 + (10 × 0.131)] = 2.814
CB = 10 × 1.15 / [1 + (10 × 0.331)] = 2.668
CD = 10 × 1.35 / [1 + (10 × 0.431)] = 2.542
CC = 10 × 1.60 / [1 + (10 × 0.639)] = 2.165
CE = 10 × 1.66 / [1 + (10 × 0.7111)] = 2.047
Cut off point is 2.814

βi ሺRi -Rf ሻ
Zi = ቈ( -C)቉
σ2ei βi
1.5
ZA = ሺ5.33-2.814ሻ = 0.09435
40
1.5
ZF = ሺ4.67-2.814ሻ = 0.0928
30
XA = 0.09435/[0.09435+0.0928] = 50.41%
XF = 0.0928/ሾ0.09435+0.0928ሿ = 49.59%
264
Funds to be invested in security A & F are 50.41% and 49.59% respectively.
Question 89
Indira has a fund of ₹3 lacs which she wants to invest in share market with rebalancing target
after every 10 days to start with for a period of one month from now. The present NIFTY is 5326.
The minimum NIFTY within a month can at most be 4793.4. She wants to know as to how she
should rebalance her portfolio under the following situations, according to the theory of Constant
Proportion Portfolio Insurance Policy, using "2" as the multiplier:
(1) Immediately to start with.
(2) 10 days later-being the 1st day of rebalancing if NIFTY falls to 5122.96.
(3) 10 days further from the above date if the NIFTY touches 5539.04.
For the sake of simplicity, assume that the value of her equity component will change in tandem
with that of the NIFTY and the risk free securities in which she is going to invest will have no
Beta.
May 12 (8 Marks), RTP May 19 (New), Practice Manual
Answer:
5326-4793.40
Maximum decline in one month = × 100 = 10%
5326
(1) Immediately to start with
Investment in equity = Multiplier × (Portfolio value – Floor value)
= 2 (3,00,000 – 2,70,000)
= ₹60,000
Indira may invest ₹60,000 in equity and balance in risk free securities.
(2) After 10 days

Value of equity = 60,000 × 5122.96/5326 = ₹57,713
Value of risk free investment = ₹2,40,000
Total value of portfolio = ₹2,97,713
= 2 (2,97,713 – 2,70,000)
= ₹55,426
Revised Portfolio:
Equity = ₹55,426
Risk free Securities = ₹2,97,713 – ₹55,426 = 2,42,287
The investor should invest ₹2287 in risk free securities and divert from Equity.
265
(3) After another 10 days

Value of equity = 55,426 × 5539.04/5122.96 = ₹59,928
Value of risk free investment = ₹2,42,287
Total value of portfolio = ₹3,02,215
= 2 (3,02,215 – 2,70,000)
= ₹64,430
Revised Portfolio:
Equity = ₹64,430
Risk Free Securities = ₹3,02,215 – ₹64,430 = ₹2,37,785
The investor should off-load ₹4502 of risk free securities and divert to Equity.
Question 90
Ms. Sunidhi is working with an MNC at Mumbai. She is well versant with the portfolio
management techniques and wants to test one of the techniques on an equity fund she has
constructed and compare the gains and losses from the technique with those from a passive
buy and hold strategy. The fund consists of equities only and the ending NAVs of the fund she
constructed for the last 10 months are given below:
Month Ending NAV (₹/unit) Month Ending NAV (₹/unit)
December 2008 40.00 May 2009 37.00
January 2009 25.00 June 2009 42.00
February 2009 36.00 July 2009 43.00
March 2009 32.00 August 2009 50.00
April 2009 38.00 September 2009 52.00
Assume Sunidhi had invested a notional amount of ₹2 lakhs equally in the equity fund and a
conservative portfolio (of bonds) in the beginning of December 2008 and the total portfolio was
being rebalanced each time the NAV of the fund increased or decreased by 15%.
You are required to determine the value of the portfolio for each level of NAV following the
Constant Ratio Plan.
MTP Oct 21 (New) (8 Marks), MTP Oct 21 (Old) (8 Marks), MTP Sept 16 (8 Marks), Practice Manual
Answer:
266
Constant Ratio Plan:

Stock Value of Value of Value of Total value Revaluatio Total No. of
Portfolio buy-hold Conservative aggressive of Constant n Action units in
NAV strategy Portfolio Portfolio Ratio Plan aggressive
portfolio
(₹) (₹) (₹) (₹) (₹)
40.00 2,00,000 1,00,000 1,00,000 2,00,000 - 2500
25.00 1,25,000 1,00,000 62,500 1,62,500 - 2500
1,25,000 81,250 81,250 1,62,500 Buy 750 3250
units
36.00 1,80,000 81,250 1,17,000 1,98,250 - 3250
1,80,000 99,125 99,125 1,98,250 Sell 496.53 2753.47
units
32.00 1,60,000 99,125 88,111.04 1,87,236.04 - 2753.47
38.00 1,90,000 99,125 1,04,631.86 2,03,756.86 - 2753.47
1,90,000 1,01,878.43 1,01,878.43 2,03,756.86 Sell 72.46 2681.01
units
37.00 1,85,000 1,01,878.50 99,197.37 2,01,075.87 - 2681.01
42.00 2,10,000 1,01,878.50 1,12,602.42 2,14,480.92 - 2681.01
43.00 2,15,000 1,01,878.50 1,15,283.43 2,17,161.93 - 2681.01
50.00 2,50,000 1,01,878.50 1,34,050.50 2,35,929 - 2681.01
2,50,000 1,17,964.50 1,17,964.50 2,35,929 Sell 321.72 2359.29
units
52.00 2,60,000 1,17,964.50 1,22,683.08 2,40,647.58 - 2359.29
Hence, the ending value of the mechanical strategy is ₹2,40,647.58 and buy & hold
strategy is ₹2,60,000.
267
Question 91
Ms. Kiran had a surplus fund of ₹2,00,000 on 31.03.2016. She is interested in constructing a
portfolio of shares of the core sectors to be weighted equally in rupee value terms. Her friend
Shaila based on her research advised her to purchase following shares:
Company No. of Shares Price Per Share
O Ltd. 100 400
H Ltd. 1000 40
A Ltd. 320 125
R Ltd. 400 100
T Ltd. 200 200
On April 1, 2016, the prices of these stocks were as follows:

Company Price Per Share
O Ltd. 300
H Ltd. 60
A Ltd. 120
R Ltd. 150
T Ltd. 125
You are required to exhibit how Kiran can rebalance her portfolio on 1.4.2016 so that her
exposure to individual stock is maintained at original level in terms of rupee value.
MTP Mar 18 (Old) (5 Marks)
Answer:
Rebalancing Action:
Company New Price Original No. Revised No. of Shares No. of
Per Share of Shares Value of to held as per Shares Buy
Portfolio Revised Price (+)/Sell (-)
O Ltd. 300 100 30,000 142.27* +42.27
H Ltd. 60 1000 60,000 711.33 -288.67
A Ltd. 120 320 38,400 355.67 +35.67
R Ltd. 150 400 60,000 284.53 -115.47
T Ltd. 125 200 25,000 341.44 +141.44
Total 2,13,400
Prop. investment in each security ₹213400/5

∗ = = = 142.27
Price of security ₹300
268
Question 92
An investor has decided to invest ₹1,00,000 in the shares of two companies, namely, ABC and
XYZ. The projections of returns from the shares of the two companies along with their
probabilities are as follows:
Probability ABC (%) XYZ (%)
20 12 16
25 14 10
25 -7 28
30 28 -2
You are required to
(i) Comment on return and risk of investment in individual shares.
(ii) Compare the risk and return of these two shares with a Portfolio of these shares in equal
proportions.
(iii) Find out the proportion of each of the above shares to formulate a minimum risk portfolio.
RTP Nov 12, MTP Sept 15 (8 Marks), MTP Sept 16 (8 Marks), RTP May 19 (New), Practice Manual
Answer:
(i)
Probability ABC (%) XYZ (%) 1 × 2 (%) 1 × 3 (%)
(1) (2) (3) (4) (5)
0.20 12 16 2.40 3.2
0.25 14 10 3.50 2.5
0.25 -7 28 -1.75 7.0
0.30 28 -2 8.40 -0.6
Average return 12.55 12.1
Hence the expected return from ABC = 12.55% and XYZ is 12.1%
Probability (ABC - ABCሻ (ABC -ABC)2 1×3 (XYZ - XYZ) (XYZ - XYZ)2 (1) × (6)
(1) (2) (3) (4) (5) (6)
0.20 -0.55 0.3025 0.06 3.9 15.21 3.04
0.25 1.45 2.1025 0.53 -2.1 4.41 1.10
0.25 -19.55 382.2025 95.55 15.9 252.81 63.20
0.30 15.45 238.7025 71.61 -14.1 198.81 59.64
167.75 126.98
269
σ2 ABC = 167.75(%)2 ; σ ABC = 12.95%

σ2 XYZ = 126.98(%)2 ; σ XYZ = 11.27%
(ii) In order to find risk of portfolio of two shares, the covariance between the two is
necessary here.
Probability (ABC - ABCሻ (XYZ - XYZ) 2×3 1×4
(1) (2) (3) (4) (5)

0.20 -0.55 3.9 -2.145 -0.429
0.25 1.45 -2.1 -3.045 -0.761
0.25 -19.55 15.9 -310.845 -77.71
0.30 15.45 -14.1 -217.845 -65.35
-144.25
σ2P = (0.52 × 167.75) + (0.52 × 126.98) + 2 × (-144.25) × 0.5 × 0.5

σ2P = 41.9375 + 31.745 – 72.125
σ2P = 1.5575 or 1.56(%)
σP = ඥ1.56 = 1.25%
E (Rp) = (0.5 × 12.55) + (0.5 × 12.1) = 12.325%
Hence, the return is 12.325% with the risk of 1.25% for the portfolio. Thus, the portfolio
results in the reduction of risk by the combination of two shares.
(iii) For constructing the minimum risk portfolio, the condition to be satisfied is
σ2X -rAX σA σX σ2X -CovAX
XABC = 2 2 or = 2 2
σA +σX -2rAX σA σX σA +σX -2CovAX
σX = Std. Deviation of XYZ

σA = Std. Deviation of ABC
rAX = Coefficient of Correlation between XYZ and ABC
Cov.AX = Covariance between XYZ and ABC.
Therefore,
126.98-(-144.25) 271.23
%ABC = = = 0.46 or 46%
126.98+167.75-[2 × ሺ-144.25ሻ] 583.23
% ABC = 46%, XYZ = 54%
270
Question 93
A two-asset portfolio contains a long position in commodity (T) with volatility of 10.0% and a long
position in stock (S) with volatility of 30.0%. The assets are uncorrelated: r (T,S) = zero (0). What
weight (0 to 100%) of the portfolio should be allocated to the commodity if the goal is a minimum
variance portfolio (in percentage terms, as no dollars are introduced)?
Answer:
𝛔s2 -CovST
WT =
𝛔2T +𝝈𝟐𝑺 -2CovST
When, r = 0
σs2 302 900
WT = 2 = = = 0.90
σT +σs2 102 +302 1000
For minimum variance portfolio invest 90% in commodity & 10% in stock.
Question 94
The following details are given for X and Y companies’ stocks and the Bombay Sensex for a
period of one year. Calculate the systematic and unsystematic risk for the companies’ stocks.
What would be the portfolio risk if equal amount of money is allocated among these stocks?
X Stock Y Stock Sensex
Average return 0.15 0.25 0.06
Variance of return 6.30 5.86 2.25
Β 0.71 0.685
Correlation Co-efficient 0.424
Co-efficient of determination (r2) 0.18
RTP May 16, StudyMat

Answer:
The co-efficient of determination (r2) gives the percentage of the variation in the security’s
return that is explained by the variation of the market index return. In the X company stock
return, 18 per cent of variation is explained by the variation of the index and 82 per cent is
not explained by the index.
According to Sharpe, the variance explained by the index is the systematic risk. The
unexplained variance or the residual variance is the unsystematic risk.
Company X
Systematic risk 2
= βi × Variance of market index
= (0.71)2 × 2.25 = 1.134
271
Unsystematic risk = Total variance of security return - Systematic risk

= 6.3 – 1.134 = 5.166
or
= Variance of Security Return (1 – r2)
= 6.3 × (1 - 0.18) = 6.3 × 0.82 = 5.166
2
Total risk βi × σm 2 +∈l 2
= 1.134 + 5.166 = 6.3
Company Y
2
Systematic risk βi × σm 2
= (0.685)2 × 2.25 = 1.056
Unsystematic risk = Total variance of the security return
systematic risk.
= 5.86 - 1.056 = 4.804
2
N N
σp = ൦ቌ∑ Xi βi ቍ σm ൪ + ቎ቌ∑ Xi 2 ∈i 2 ቍ቏
2 2
i=1 i=1
= [(0.5 × 0.71 + 0.5 × 0.685)2 2.25] + [(0.5)2(5.166) + (0.5)2(4.804)]

= [(0.355 + 0.3425)2 2.25] + [(1.292 + 1.201)]
= 1.0946 + 2.493
= 3.5876
Question 95
Mr. A is holding 1000 shares of face value of ₹100 each of M/s. ABC Ltd. He wants to hold these
shares for long term and have no intention to sell.
On 1st January 2020, M/s XYZ Ltd. has made short sales of M/s. ABC Ltd.’s shares and
approached Mr. A to lend his shares under Stock Lending Scheme with following terms:
(i) Shares to be borrowed for 3 months from 01-01-2020 to 31-03-2020,
(ii) Lending Charges/Fees of 1% to be paid every month on the closing price of the stock
quoted in Stock Exchange and
(iii) Bank Guarantee will be provided as collateral for the value as on 01 -01-2020.
Other Information:
a. Cost of Bank Guarantee is 8% per annum,
b. On 29-02-2020 M/s. ABC Ltd.’s share quoted in Stock Exchange on various dates are as
follows:
272
Date Share Price in Share Price in

Scenario -1 Bullish Scenario -2 Bullish
01-01-2020 1000 1000
31-01-2020 1020 980
29-02-2020 1040 960
31-03-2020 1050 940
You are required to find out:

(i) Earning of Mr. A through Stock Lending Scheme in both the scenarios,
(ii) Total Earnings of Mr. A during 01-01-2020 to 31-03-2020 in both the scenarios,
(iii) What is the Profit or loss to M/s. XYZ by shorting the shares using through Stock Lending
Scheme in both the scenarios?
Jan 21 (Old) (8 Marks), RTP May 22
Answer:
Scenario 1 Scenario 2
(i) Earnings of Mr. A through stock lending scheme
Lending fee
31-01-20 1020 × 1% and 980 × 1% 10.20 9.80
29-02-20 1040 × 1% and 960 × 1% 10.40 9.60
31-03-20 1050 × 1% and 940 × 1% 10.50 9.40
Earnings from lending per Share (A) 31.10 28.80
Total No. of Shares 1000 1000
Total Earning from Lending 31,100 28,800
(ii) Total Earnings of Mr. A during 01-01-2020 to 31-01-2020
Dividend income per Share (B) 25.00 25.00
Total earnings per share (A) + (B) 56.10 53.80
Total Earning 56,100 53,800
(iii) Profit or loss to M/s. XYZ
Gain on shortening the shares
(1,000 – 1,050) and (1,000 - 940) (50.00) 60.00
Lending fees paid (31.10) (28.80)
Bank guarantee charges @ 8% (20.00) (20.00)
Gain Per Share (101.10) 11.20
Total Gain on shortening the shares (1,01,100) 11,200
273
CA Mayank Kothari 7. Mutual Funds
CHAPTER 7
MUTUAL FUNDS
Question 1
A mutual fund that had a net asset value of ₹16 at the beginning of a month, made income and
capital gain distribution of ₹0.04 and ₹0.03 respectively per unit during the month, and then
ended the month with a net asset value of ₹16.08. Calculate monthly and annual rate of return.
MTP Apr 14 (6 Marks), MTP Aug 16 (6 Marks), MTP May 20 (Old) (4 Marks), Practice Manual, StudyMat
Answer:
Calculation of monthly return on the mutual funds
ሺNAVt -NAVt-1 ሻ+lt +Gt
r=
NAVt-1
ሺ₹16.08-₹16.00ሻ+(₹0.04+₹0.03)
=
16
0.08+0.07
= = 0.009375 or = 0.9375% or 11.25% p.a.
16
Question 2
A mutual fund having 300 units has shown its NAV of ₹8.75 and ₹9.45 at the beginning and at
the end of the year respectively. The Mutual fund has given two options to the investors:
(i) Get dividend of ₹0.75 per unit and capital gain of ₹0.60 per unit, or
(ii) These distributions are to be reinvested at an average NAV of ₹8.65 per unit.
What difference would it make in terms of returns available and which option is preferable by
the investors?
RTP May 14, MTP Oct 14 (6 Marks), MTP Mar 18 (New) (8 Marks), Nov 18 (New) (8 Marks), Nov 17 (5
Marks), RTP May 12, Practice Manual
Answer:
Option 1: When Dividend and Capital Gain are paid:
Calculation of monthly return on the mutual funds:
ሺNAVt -NAVt-1 ሻ+lt +Gt
r=
NAVt-1
ሺ₹9.45-₹ 8.75ሻ+(₹0.75+₹ 0.60) 0.70+1.35
r= = = 23.43%
8.75 8.75
Option 2: When Dividend and Capital Gain are reinvested:
If all dividends and capital gain are reinvested into additional units at ₹8.65 per
unit the position would be.
Total amount reinvested = ₹1.35 × 300 = ₹405
274
₹405
Additional units added = = 46.82 units or 47 units
8.65
Value of units at the end = 346.82 units × ₹9.45 = ₹ 3277.45
Or = 347 units × ₹9.45 = ₹ 3279.15
Price paid for 300 units as at the beginning = (300 × ₹8.75) = ₹2,625
Return = (₹3277.45 - ₹2625) / ₹2625 = 24.86 %
₹3279.15-₹2625 ₹654.15
Or Return = = = 24.92%
₹2625 ₹2625
From the above, it can be said that reinvestment option is better.
Question 3
Orange purchased 200 units of Oxygen Mutual Fund at ₹45 per unit on 31st December 2009.
In 2010, he received ₹1.00 as dividend per unit and a capital gains distribution of ₹2 per unit.
Required:
(i) Calculate the return for the period of one year assuming that the NAV as on 31st
December 2010 was ₹48 per unit.
(ii) Calculate the return for the period of one year assuming that the NAV as on 31st
December 2010 was ₹48 per unit and all dividends and capital gains distributions have
been reinvested at an average price of ₹46.00 per unit.
Ignore Taxation.
Nov 11 (5 Marks), MTP Mar 16 (5 Marks), RTP May 16, MTP Mar 19 (New) (8 Marks), RTP May 20
(Old), MTP Oct 18 (Old) (5 Marks), May 11 (8 Marks), MTP Aug 17, MTP Oct 19 (New) (8 Marks)
Answer:
(i) Returns for the year
(All changes on a Per - Unit Basis)
Change in Price: ₹48 – ₹45 = ₹3.00
Dividends received: ₹1.00
Capital gains distribution ₹2.00
Total reward ₹6.00
Holding period reward: ₹6.00
× 100 = 13.33%
₹45
275
(ii) When all dividends and capital gains distributions are re-invested into additional
units of the fund @ (₹46/unit)
Dividend + Capital Gains per unit = ₹1.00 + ₹2.00 = ₹3.00
Total received from 200 units = ₹3.00 x 200 = ₹600/-
Additional Units Acquired = ₹600/₹46 = 13.04 Units.
Total No. of Units = 200 units + 13.04 units = 213.04 units.
Value of 213.04 units held at the = 213.04 units x ₹48 = ₹10225.92
end of the year
Price Paid for 200 Units at the = 200 units x ₹45 = ₹9000.00
beginning of the year
Holding Period Reward = ₹1225.92
₹(10225.92 – 9000.00)
Holding Period Reward ₹1225.92
= × 100 = 13.62%
₹9000
Question 4
The NAV of per unit of XYZ Mutual Fund (a Close Ended Funds) on 1.1.2014 was ₹28. The
value on 31.12.2014 comes to ₹28.80. On the same date unit was trading in market at a
premium of 3% though on 1.1.2014 same was trading at a discount at 5%. On 31.12.2014,
XYZ distributed a sum of ₹2.80 as incomes and capital gains. You are required to compute
rate of return to the investor during the year.
MTP Sep 15 (5 Marks)
Answer:
Price of each unit on 1.1.2014 = ₹28 × 0.95 = ₹26.60
Price of each unit on 31.12.2014 = ₹28.80 × 1.03 = ₹29.66
The price of fund increases by = ₹3.06 (29.66 – 26.60)
2.8+3.06
Rate of Return = × 100 = 22.03%
26.60
Question 5
The following information is extracted from Steady Mutual Fund’s Scheme:
- Asset Value at the beginning of the month - ₹65.78
- Annualised return -15 %
- Distributions made in the nature of Income - ₹0.50 and ₹0.32 & Capital gain (per unit
respectively).
276
(1) Calculate the month end net asset value of the mutual fund scheme (limit your answers to
two decimals).
(2) Provide a brief comment on the month end NAV.
Nov 12 (5 Marks), MTP Oct 15 (5 Marks), MTP April 14 (8 Marks), Practice Manual
Answer:
(1) Calculation of NAV at the end of month:
Given Annual Return = 15%
Hence Monthly Return = 1.25% (r)
ሺNAVt -NAV1-t ሻ+It +Gt
r=
NAV1-t
ሺNAVt -₹65.78ሻ+₹0.50+₹0.32
0.0125 =
65.78
0.82 = NAVt -₹64.96
NAVt = ₹65.78
(2) There is no change in NAV.
Question 6
The unit price of Equity Linked Savings Scheme (ELSS) of a mutual fund is ₹10/-. The public
offer price (POP) of the unit is ₹10.204 and the redemption price is ₹9.80.
Calculate:
(i) Front end Load
(ii) Back end Load
May 18 (Old) (5 Marks), Practice Manual
Answer:
Public Offer Price = NAV/ (1 – Front end Load)
Public Offer Price: ₹10.204 and NAV: ₹10 NAV
Accordingly, POP =
1 − FEL
10.204 = 10/ (1 – F)
F = 0.0199 say 2%
Redemption Price = NAV/ (1 + Back end Load)

NAV
₹9.80 = 10/ (1 + Back end Load) RP =
1 + BEL
B = 0.0204 i.e. 2.04%
Alternatively,
277
10.204-10
ሺiሻ Front End Load = = 0.0204 or 2.04%
10.00
10.00-9.80
ሺiiሻ Exit Load = = 0.020 or 2.00%
10.00
Question 7
During the year 2017 an investor invested in a mutual fund. The capital gain and dividend for
the year was ₹3.00 per unit, which were re-invested at the yearend NAV of ₹23.75. The investor
had total units of 26,750 as at the end of the year. The NAV had appreciated by 18.75% during
the year and there was an entry load of ₹0.05 at the time when the investment was made.
The investor lost his records and wants to find out the amount of investment made and the
entry load in the mutual fund.
Answer:
₹23.75
NAV in the Beginning of year = × 100 = ₹20
118.75
No. of Units after Bonus issue = 26,750

Let x be the No. of Units acquired then
x×3
26,750 = x+
23.75
x = 23,750 units
Investment Amount = 23,750 units (₹20 + ₹0.05) = ₹4,76,187.50

Entry load = ₹1,187.50 i.e. (23750 × ₹0.05)
Question 8
Mr. A can earn a return of 16 per cent by investing in equity shares on his own. Now he is
considering a recently announced equity based mutual fund scheme in which initial expenses
are 5.5 per cent and annual recurring expenses are 1.5 per cent. How much should the mutual
fund earn to provide Mr. A return of 16 per cent?
RTP May 13, Practice Manual, StudyMat
Answer:
Personal earnings of Mr. A = R1 = 16%
Mutual Fund earnings = R2
1
R2 = R + Recurring Expenses(%)
1-Initial expenses(%) 1
278
1
= × 16%+1.5%
1-0.055
= 18.43%
Mutual Fund Earnings = 18.43%
Question 9
Mr. X earns 10% on his investments in equity shares. He is considering a recently floated
scheme of a Mutual Fund where the initial expenses are 6% and annual recurring expenses
are expected to be 2%. How much the Mutual Fund scheme should earn to provide a return of
10% to Mr. X?
June 09 (2 Marks), Practice Manual, StudyMat
Answer:
1
r2 = × r1 +recurring expenses
1-initial expenses
The rate of return the mutual fund should earn;
1
= × 0.1+0.02
1-0.06
= 0.1264 or 12.64%
Question 10
Mr. Alex, a practicing Chartered Accountant, can earn a return of 15 percent by investing in
equity shares on his own. He is considering a recently announced equity based mutual fund
scheme in which initial expenses are 6 percent and annual recurring expenses are 2 percent.
(i) How much should the mutual fund earn to provide Mr. Alex a return of 15 percent per
annum?
(ii) Mr. Alex's current Annual Professional Income is ₹ 40 Lakhs. His portfolio value is ₹50
Lakhs and now he is spending 10% of his time to manage his portfolio. If he spends this
time on profession, his professional income will go up in same proportion. He is thinking to
invest his entire portfolio into a Multicap Fund, assuming the fund's NAV will grow at 13%
per annum (including dividend).
You are requested to advise Mr. Alex, whether he can invest the portfolio into Multicap Funds?
If so, what is the net financial benefit?
Answer:
(i) Personal earnings of Mr. Alex = R1 = 15%
Mutual Fund earnings = R2
279
1
R2 = R +Recurring expenses(%)
1-Initial expense(%) 1
1
= × 15%+2%
1-0.06
= 17.96%
Mutual Fund earnings = 17.96%
(ii) Net financial benefit to Mr. Alex if he invests his portfolio in Fund:
Present Income of Mr. Alex
₹ Lakhs
Annual Professional Income (A) 40.00
Portfolio Value 50.00
Income on his Portfolio @ 15% (B) 7.50
Total Income (A) + (B) 47.50
Expected Income of Mr. Alex after investing the Portfolio in Multi-cap Fund:
₹ Lakhs
Annual Professional Income (A) 40.00
Additional Professional Income (B) 4.00
Portfolio Value 50.00
Income on his Portfolio @ 13% (C) 6.50
Total Income (A) + (B) + (C) 50.50
It is advisable to invest in Multi-cap Mutual Funds and devote the time on profession. He
will get net benefit of ₹3 Lakhs (₹50.50 - ₹47.50)
Question 11
Mr. A has invested in three Mutual Fund (MF) schemes as per the details given below:
Particulars MF ‘A’ MF ‘B’ MF ‘C’
Date of Investment 01/11/2015 01/02/2016 01/03/2016
Amount of investment (₹) 1,00,000 2,00,000 2,00,000
Net Asset Value (NAV) at entry date (₹) 10.30 10.00 10.10
Dividend Received upto 31-3-2016 (₹) 2,850 4,500 NIL
NAV as on 31-3-2016 (₹) 10.25 10.15 10.00
280
Assume 1 year = 365 days.

Show the amount of rupees upto two decimal points.
You are required to find out the effective yield (upto three decimal points) on per annum basis
in respect of each of the above three Mutual Fund (MF) schemes upto 31-3-2016.
Answer:
Particulars MF ‘A’ MF ‘B’ MF ‘C’
(a) Investments ₹1,00,000 ₹2,00,000 ₹2,00,000
(b) Opening NAV ₹10.30 ₹10.00 ₹10.10
(c) No. of units (a/b) 9,708.74 20,000 19,801.98
(d) Unit NAV ON 31-3-2016 ₹10.25 ₹10.15 ₹10.00
(e) Total NAV on 31-3-2016 (c × d) ₹99,514.59 ₹2,03,000 ₹1,98,019.86
(f) Increase / Decrease of NAV (a-e) (₹485.41) ₹3,000 (₹1,980.14)
(g) Dividend Received ₹2,850 ₹4,500 Nil
(h) Total yield (f + g) ₹2,364.59 ₹7,500 (₹1,980.20)
(i) Number of Days 152 60 31
(j) Effective yield p.a. (h/a × 365/i × 100) 5.678% 22.813% (-) 11.657%
Question 12
Mr. K has invested in three Mutual fund schemes as per details below:
Scheme A Scheme B Scheme C
Date of Investment 01-12-2018 01-01-2019 01-03-2019
Amount of Investment ₹5,00,000 ₹10,00,000 ₹5,00,000
Net Asset Value at entry ₹10.50 ₹10.00 ₹10.00
date
Dividend received up to 31-03-2019 ₹9,500 ₹15,000 ₹5,000
NAV as at 31-3-2019 ₹10.40 ₹10.10 ₹9.80
You are required to calculate the effective yield on per annum basis in respect of each of the
three schemes to Mr. K upto 31-03-2019, taking the year consisting of 365 days.
Provide a brief, comment on the course of action he should take for future period.
(Calculation should be upto three decimal places)
July 21 (8 Marks), May 15 (4 Marks), RTP Nov 12, RTP Nov 12, StudyMat
281
Answer:
Calculation of effective yield on per annum basis in respect of three mutual fund
schemes to Mr. K up to 31-03-2019:
Particulars Scheme A Scheme B Scheme C
(a) Investments ₹5,00,000 ₹10,00,000 ₹5,00,000
(b) Opening NAV ₹10.50 ₹10.00 ₹10.00
(c) No. of units (a/b) 47,619.048 1,00,000 50,000
(d) Unit NAV on 31-3-2019 ₹10.40 ₹10.10 ₹9.80
(e) Total NAV on 31-3-2019 (c × d) ₹4,95,238.099 ₹10,10,000 ₹4,90,000
(f) Increase / Decrease of NAV (e - a) (₹4,761.901) ₹10,000 (₹10,000)
(g) Dividend Received ₹9,500 ₹15,000 ₹5,000
(h) Total yield (f + g) ₹4,738.099 ₹25,000 (₹5,000)
(i) Number of Days 121 90 31
(j) Effective yield p.a. (h/a x 365/i × 100) 2.859% 10.139% (-) 11.774%
Comments: Since the Effective Yield in Scheme C is negative and that of Scheme A is much
lower than Scheme B, it is advised that Mr. K should redeem the investments in Scheme A and
Scheme C and the proceeds should be invested in Scheme B in the next period.
Question 13
Mr. Suhail has invested in three Mutual Fund Schemes as given below:
Particulars Scheme A Scheme B Scheme C
Date of investment 1-4-2011 1-5-2011 1-7-2011
Amount of Investment (₹) 12,00,000 4,00,000 2,50,000
Net Asset Value (NAV) at entry date (₹) 10.25 10.15 10.00
Dividend received up to 31-7-2011 (₹) 23,000 6,000 Nil
NAV as at 31-7-2011 (₹) 10.20 10.25 9.90
You are required to calculate the effective yield on per annum basis in respect of each of the
three Schemes to Mr. Suhail up to 31-7-2011.
Take one year = 365 days.
Show calculations up to two decimal points.
May 13 (10 Marks)
282
Answer:
Scheme Investment Unit Nos. Unit NAV Total NAV 31.7.2011
₹ (Investment/NAV at 31.7.2011 (Unit Nos. × Unit NAV as
entry date) ₹ on 31.7.2011) ₹
MF A 12,00,000 1,17,073.17 10.20 11,94,146.33
MF B 4,00,000 39,408.87 10.25 4,03,940.92
MF C 2,50,000 25,000 9.90 2,47,500.00
Scheme NAV (+) / (–) Dividend Total Yield Number Effective Yield (% p.a.)
(NAV as on Received Change in of days (Total Yield/
31.7.2011 – (₹) NAV + Investment) × (365/No.
Investment) (₹) Dividend (₹) of days) × 100
MF A (-)5,853.67 23,000 17,146.33 122 4,275%
MF B (+)3,940.92 6,000 9,940.92 92 9.86%
MF C (-) 2,500 Nil (-) 2,500 31 (-) 11.77 %
Question 14
Mr. Y has invested in the three mutual funds (MF) as per the following details:
Particulars MF ‘X’ MF ‘Y’ MF ‘Z’
Amount of Investment (₹) 2,00,000 4,00,000 2,00,000
Net Assets Value (NAV) at the time of purchase (₹) 10.30 10.10 10
Dividend Received up to 31.03.2018 (₹) 6,000 0 5,000
NAV as on 31.03.2018 (₹) 10.25 10 10.20
Effective Yield per annum as on 31.03.2018 (percent) 9.66 -11.66 24.15
Assume 1 Year = 365 days

Mr. Y has misplaced the documents of his investment. Help him in finding the date of his original
investment after ascertaining the following:
(i) Number of units in each scheme;
(ii) Total NAV;
(iii) Total Yield; and
(iv) Number of days investment held.
May 18 (Old) (8 Marks), MTP Apr 19 (Old) (8 Marks), MTP Oct 20 (New) (8 Marks), MTP Oct 20 (Old)
(8 Marks), Practice Manual, StudyMat
Answer:
283
(i) Number of Units in each Scheme

2,00,000
MF ‘X’ = 19,417.48
10.30
4,00,000
MF ‘Y’ = 39,603.96
10.10
2,00,000
MF ’Z’ = 20,000.00
10.00
(ii) Total NAV on 31.03.2018

MF ‘X’ = 19,417.48 × ₹ 10.25 ₹1,99,029.17
MF ‘Y’ = 39,603.96 × ₹ 10.00 ₹3,96,039.60
MF ‘Z’ = 20,000.00 × ₹10.20 ₹2,04,000.00
Total ₹7,99,068.77
(iii) Total Yield

Capital Yield Dividend Yield Total
MF ‘X’ ₹1,99,029.17- ₹ 2,00,000 = - ₹ 970.83 ₹6,000 ₹5,029.17
MF ‘Y’ ₹3,96,039.60 - ₹4,00,000 = - ₹3,960.40 Nil - ₹3,960.40
MF ‘Z’ ₹2,04,000 - ₹2,00,000 = ₹4,000 ₹5,000 ₹9,000.00
Total ₹10,068.77
10,068.77
Total Yield = × 100 = 1.2586%
8,00,000
(iv) No. of Days Investment Held

MF ‘X’ MF ‘Y’ MF ‘Z’
Let No. of days be X Y Z
Initial Investment (₹) 2,00,000 4,00,000 2,00,000
Yield (₹) 5,029.17 -3,960.40 9,000.00
Yield (%) 2.5146 - 0.9901 4.5
2.5146 -0.9901 4.5
Period of Holding (Days) × 365 = 95 Days × 365 = 31 Days × 365 = 68 Days
9.66 -11.66 24.15
Date of Original Investment 26.12.17 28.02.18 22.01.18
284
Question 15
A Mutual Fund Company introduces two schemes - Dividend Plan and Bonus Plan. The face
value of the Unit is ₹10 on 1-4-2014. Mr. R invested ₹5 lakh in Dividend Plan and ₹10 lakh in
Bonus Plan. The NAV of Dividend Plan is ₹46 and NAV of Bonus Plan is ₹42. Both the plans
matured on 31-03-2019. The particulars of Dividend and Bonus declared over the period are as
follows:
Date Dividend % Bonus Ratio NAV of Dividend Plan NAV of Bonus Plan
₹ ₹
31-12-2014 12% - 47.0 42.0
30-09-2015 - 1:4 48.0 43.0
31-03-2016 15% - 49.5 41.5
30-09-2017 - 1:6 50.0 44.0
31-03-2018 10% - 48.0 43.5
31-03-2019 - - 49.0 44.0
You are required to calculate the effective yield per annum in respect of the above two plans.
May 19 (New) (8 Marks), StudyMat
Answer:
(a) Dividend Plan
5,00,000
Unit acquired = = 10869.57
46
Date Units held Dividend Reinvestment New Total
% Amount Rate Units Units
01.04.2014 10869.57
31.12.2014 10869.57 12 13043.48 47.0 277.52 11147.09
31.03.2016 11147.09 15 16720.64 49.5 337.79 11484.88
31.03.2018 11484.88 10 11484.88 48.0 239.27 11724.15
31.03.2019 Maturity Value (₹49.0 × 11724.15) ₹5,74,483.35
Less: Cost of Acquisition ₹5,00,000.00
Total Gain ₹74483.35
₹74,483.35 1
∴Effective Yield = × × 100 = 2.98%
₹5,00,000 5
285
(b) Bonus Plan

10,00,000
Units Acquired = = 23809.52
42
Date Particulars Calculation Working No. of Units NAV (₹)
1.4.14 Investment 23809.52 42
30.9.15 Bonus 23,809.52 / 4 = 5952.38
29761.90 43
30.9.17 “ 29761.9 / 6 = 4960.32
34722.22 44
31.3.19 Maturity Value 34722.22 × ₹44 15,27,777.68
Less: Investment 10,00,000.00
Total Gain 5,27,777.68
5,27,777.68 1
∴Effective Yield = × × 100 = 10.56%
10,00,000 5
Question 16
A mutual fund has two schemes i.e. Dividend plan (Plan-A) and Bonus plan (Plan-B). The face
value of the unit is ₹10. On 01/04/2016 Mr. Anand invested ₹5,00,000 each in Plan-A and Plan-
B when the NAV was ₹46.00 and ₹43.50 respectively, Both the Plans matured on 31/03/2019.
Particulars of dividend and bonus declared over the period are as follows:
Date Dividend (%) Bonus ratio Net Assets Value (₹)
Plan – A Plan – B
30-06-2016 15% 46.80 44.00
31-08-2016 1:6 47.20 45.40
31-03-2017 10% 48.00 46.60
17-09-2017 1:8 48.40 47.00
21-11-2017 14% 49.60 47.20
25-02-2018 15% 50.00 47.80
31-03-2018 1 : 10 50.50 48.80
30-06-2018 12% 51.80 49.00
31-03-2019 52.40 50.00
You are required to calculate the Effective Yield Per annum in respect of the above two plans.
* Wrongly got printed as respective.
May 19 (Old) (8 Marks), Practice Manual
286
Answer:
Plan – A
Unit acquired = 5,00,000/46.00 = 10869.57
Date Units held Dividend Reinvestment New Total
% Amount Rate Units Units
01.04.2016 -- -- -- -- -- 10869.57
30.06.2016 10869.57 15 16304.36 46.80 348.38 11217.95
31.03.2017 11217.95 10 11217.95 48.00 233.71 11451.66
21.11.2017 11451.66 14 16032.32 49.60 323.23 11774.89
25.02.2018 11774.89 15 17662.34 50.00 353.25 12128.14
30.06.2018 12128.14 12 14553.77 51.80 280.96 12409.10
31.03.2019 Maturity Value (₹52.40 × 12409.10) ₹6,50,236.84
Less: Cost of Acquisition ₹5,00,000.00
Total Gain ₹1,50,236.84
∴ Effective Yield = (1,50,236.84 / 5,00,000) × (1/3) = 10.02%

Alternatively, it can be computed by using the IRR method as follows:
NPV at 8% = -5,00,000 + 5,16,179 = 16,179
NPV at 12% = -5,00,000 + 4,62,826 = -37,174
NPV at LR 16179
IRR = LR+ ሺHR-LRሻ = 8% × 4% = 9.21%
NPV at LR-NPV at HR 53353
Plan – B
Date Particulars Calculation Working No. of Units NAV (₹)
1.04.16 Investment ₹5,00,000/43.50 = 11494.25 43.50
31.08.16 Bonus 11494.25/6 = 1915.71 47.20
13409.96
17.09.17 “ 13409.96/8 = 1676.24 47.00
15086.20
31.03.18 “ 15086.20/10 = 1508.62 48.80
16594.82
31.03.19 Maturity Value 16594.82 × ₹50.00 = 8,29,741.00
Gain 3,29,741.00
287
∴ Effective Yield = (3,29,741.00/ 5,00,000) × (1/3) = 21.98%
Alternatively, it can be computed by using the IRR method as follows:

NPV at 20% = -5,00,000 + 4,80,174 = - 19,825
NPV at 18% = -5,00,000 + 5,05,006 = 5,006
NPV at LR
IRR = LR+ (HR-LR)
NPV at LR-NPV at HR
5006
= 18%+ × 2% = 18.40%
5006+19825
Question 17
Cinderella Mutual Fund, an approved mutual fund, sponsored open-ended equity oriented
scheme "Rudolf Opportunity Fund". There are three plans under the scheme viz. 'A' - Dividend
Re-investment plan, 'B' - Bonus plan and 'C' - Growth plan.
At the time of initial public offer on 1-4-2009, Mr. Amit, Mr. Ashish and Mr. Arun, three investors
invested ₹2,00,000 each at face value of ₹10 per unit and chosen plan 'B', 'C' and 'A'
respectively.
The particulars of the fund over the period are as follows:
Date Dividend % Bonus Ratio Net Asset Value per unit (₹)
Plan A Plan B Plan C
31.07.2013 10 - 30.70 31.20 35.40
31.03.2014 35 5:4 58.42 31.05 58.25
30.10.2017 20 - 42.18 26.45 56.45
15.03.2018 12.50 - 46.45 27.72 62.78
31.03.2018 - 1:3 45.20 20.05 67.12
25.03.2019 20 1:4 48.10 19.95 71.42
31.07.2019 - - 53.75 22.98 82.07
On 31st July, 2019, all the three investors redeemed all the balance units.
1. Consider the following:
(a) Long-term capital gain is exempt from Income-tax.
(b) Short-term capital gain is subject to 10% Income-tax.
(c) Security Transaction Tax is 0.2% only on sale/ redemption of units.
(d) Ignore Education Cess.
2. You are required:
288
(i) To calculate the Effective Yield per annum (annual rate of return) of each of the
investors.
(ii) To suggest the name of investor with the highest Effective Yield per annum with the
difference to his nearest investor.
(Show your calculations up to two decimal points)
Nov 19 (New) (10 Marks), RTP May 18 (New), Practice Manual
Answer:
(i) Calculation of effective yield per annum of each of the investors
Mr. Arun Plan A Dividend Reinvestment

(Amount in ₹)
Date Investment Dividend Dividend Re- NAV Units Closing Unit
payout invested Balance
(%) (Closing Units ×
Face value of
‘10 × Dividend
Payout %)
01.04.2009 2,00,000.00 10.00 20,000.00
31.07.2013 10 20,000.00 30.70 651.47 20,651.47
31.03.2014 35 72,280.15 58.42 1,237.25 21,888.72
30.10.2017 20 43,777.44 42.18 1,037.87 22,926.59
15.03.2018 12.5 28,658.24 46.45 616.97 23,543.56
25.03.2019 20 47,087.12 48.10 978.94 24,522.50
Redemption value 24522.5 × 53.75 13,18,084.38
Less: Security Transaction Tax (STT) is 0.2% 2636.17
Net amount received 13,15,448.21
≈ 542.33
Less: Short term capital gain tax @ 10% on 978.94 (53.64* – 48.10 )
= 5423.33
Net of tax 13,14,905.88
11,14,905.88
*(53.75 – STT @ 0.2%) ≈ This value can also be taken as zero

11,14,905.88 12
Annual average returnሺ%ሻ = × × 100 = 53.95%
2,00,000 124
289
Mr. Amit Plan B – Bonus

(Amount in ₹)
Date Units Bonus units Total Balance NAV per unit
01.04.2009 20,000 20,000 10
31.03.2014 25,000 45,000 31.05
31.03.2018 15,000 60,000 20.05
25.03.2019 15,000 75,000 19.95
Redemption value 75,000 × 22.98 17,23,500
Less: Security Transaction Tax (STT) is 0.2% 3447
Net amount received 17,20,053
Less: Short term capital gain tax @ 10%
15,000 × (22.93† – 19.95) = 44,700 4470
Net of tax 17,15,583

Less: Investment 2,00,000
Net gain 15,15,583
†(22.98 – STT @ 0.2%)

15,15,583 12
2,00,000 124
Mr. Ashish Plan C – Growth

Particulars (Amount in ₹)
Redemption value 20,000 × 82.07 16,41,400.00
Less: Security Transaction Tax (S.T.T) is 0.2% 3282.80
Net amount received 16,38,117.20
Less: Short term capital gain tax @ 10% 0.00
Net of tax 16,38,117.20
Net gain 14,38,117.20
14,38,117.20 12
2,00,000 124
290
(ii) Mr. Amit (Bonus Plan) earns the highest effective yield per annum of 73.33% and the
difference to his nearest investor Mr. Ashish is 3.74 (73.33 – 69.59%).
Note: Alternatively, figure of * and † can be taken as without net of Tax because, as per
Proviso 5 of Section 48 of IT Act, no deduction of STT shall be allowed in computation
of Capital Gain.
In such case:
Mr. Arun Plan A – Short term capital gains tax would be ₹553.10. Accordingly Net of
tax will be ₹13,14,895.10 and the net gain would be ₹11,14,895.10.
Mr. Amit Plan B – Bonus Plan – Short term capital gains tax would be ₹4,545.
Accordingly Net of tax will be ₹17,15,508 and the net gain would be ₹15,15,508.
Question 18
M/S. Corpus an AMC, on 1.04.2015 has floated two schemes viz. Dividend Plan and Bonus
Plan. Mr. X, an investor has invested in both the schemes. The following details (except the
issue price) are available:
Date Dividend (%) Bonus Ratio NAV
Dividend Plan Bonus Plan
1.04.2015 ? ?
31.12.2016 1 :4 47 40
(One unit on 4 units held)
31.03.2017 12 48 42
31.03.2018 10 50 39
31.12.2018 1 :5 46 43
(One unit on 5 units held)
31.03.2019 15 45 42
31.03.2020 - - 49 44
Additional details
Investment (₹) ₹9,20,000 ₹10,00,000
Average Profit (₹) ₹27, 748.60
Average Yield (%) 6.40
You are required to calculate the issue price of both the schemes as on 1.04.2015.
291
Answer:
(i) Dividend Plan
(a) Average Annual gain over a period of 5 Years 27748.60
(b) Total gain over a period of 5 years (a*5) 138743
(c) Initial Investment 920000
(d) Total value of investment (b+c) 1058743
(e) NAV as on 31.3.2020 49
(f) Number of units at the end of the period as on 31.03.2019 (d/e) 21607
1 2 3 4 = (2*3) 5 6 = 1/ 7
(4+5)*4
Period Units Rate Unit Dividend NAV New Units* Balance
held value Units Pre-
Dividend
31.03.2019 21607 0.15 10 1.5 45 697 20910
31.03.2018 20910 0.1 10 1 50 410 20500
31.03.2017 20500 0.12 10 1.2 48 500 20000
Issue Price as on 01 04.2015 Investment 920000/ Units purchased 20000 (c/i) = ₹46
* Let the units issued be X
X = (Closing Units/NAV + Dividend) × Dividend
(ii) Bonus Plan

(a) Average Yield 0.064
(b) Investment 1000000
(c) Gain over a period of 5 years (a*b*5) 320000
(d) Market Value as on 31.03.2019 (b + c) 1320000
(e) NAV as on 31.03.2020 44
(f) Total units as on 31.03.2020 (d/e) 30000
(g) No of units as on 31.03.2018 Pre bonus = 30000*5/ (5 + 1) 25000
(h) No of units as on 31.12.2016 Pre bonus = 25000*4/ (4 + 1) 20000
(i) Issue Price as on 01.04.2015 Investment 1000000/ Units 50
purchased 20000 (b/h)
292
Question 19
M/s. Enterprise, an Asset Management Company (AMC) on 1.04.2016 has floated a scheme
“Dividend Plan”. Mr. X, an investor, has invested in the scheme. Dividend is given in the form
of units. The details (except the issue price) are as follows:
Date Dividend (%) NAV
1.04.2016 ?
31.03.2018 20 48
31.03.2019 25 50
31.03.2020 30 45
31.03.2021 - 49
Initial Investment (₹) ₹18,40,000
Average Profit (₹) over 5 years ₹54,576
You are required to calculate the issue price of the scheme as on 01.04.2016 to ascertain the
capital appreciation. Assume face value of units as ₹10/-
Dec 21 (Old) (5 Marks)
Answer:
Particulars ₹
(a) Amount invested by Mr. X 18,40,000
(b) Gains during 5 year [₹54,576 × 5] 2,72,880
(c) Value of investment as on 31/3/21 (a) + (b) 21,12,880
(d) NAV as on 31.03.21 ₹49 per unit
(e) Total Number of units as on 31.03.21 ₹43,120 units
Let us as assume N, be the no. of units on 31.03.2020 then

₹10×N1 ×0.30
= +N1 =43,120
45
N1
+N =43,120
15 1
N1 =40,425
Now let us assume N2 be number of units on 31.03.19, then

₹10×N2 ×0.25
= +N2 =40,425
50
N2
+N =40,425
20 2
N2 =38,500
293
Now let us assume N3 be number of units on 31.03.18, then

₹10×N3 ×0.20
= +N3 =38,500
48
N3
+N =38,500
24 3
N3 =36,960
18,40,000
NAV as on 1.04.16 = =₹49.78
36,960
Thus, issue price of unit is ₹49.78
Question 20
A mutual fund raised ₹150 lakhs on April 1, 2018 by issue of 15 lakh units at ₹10 per unit. The
fund invested in several capital market instruments to build a portfolio of ₹140 lakhs, Initial
expenses amounted to ₹8 lakhs. During the month of April, the fund sold certain instruments
costing ₹44.75 lakhs for ₹47 lakhs and used the proceeds to purchase certain other securities
for ₹41.6 lakhs. The fund management expenses for the month amounted to ₹6 lakhs of which
₹50,000 was in arrears. The fund earned dividends amounting to ₹1.5 lakhs and it distributed
80% of the realized earnings. The market value of the portfolio on 30th April 2018 was ₹147.85
lakhs.
An investor subscribed to 1000 units on April 1 and disposed it off at closing NAV on 30th April.
Determine his annual rate of earnings.
Nov 18 (Old) (8 Marks), MTP May 20 (New) (8 Marks), MTP March 21 (New) (8 Marks), MTP March 21 (Old) (8 Marks)
Answer:
Amount in Amount in
₹ lakhs ₹ lakhs
Opening Bank (150 - 140 - 8) 2.00
Add: Proceeds from sale of securities 47.00
Add: Dividend received 1.50 50.50
Deduct:
Cost of securities purchased 41.60
Fund management expenses paid 5.50
Capital gains distributed = 80% of (47 – 44.75) 1.80
Dividend distributed = 80% of 1.50 1.20 50.10
Closing Bank 0.40
294
Closing market value of portfolio 147.85

148.25
Less: Arrears of expenses 0.50
Closing Net Assets 147.75
Number of units (Lakhs) 15
Closing NAV per unit (147.75/15) 9.85
Rate of Earning (Per Unit)

Amount
Income received (₹1.20 + ₹1.80)/15 ₹0.20
Loss: Loss on disposal (₹150 - ₹147.75)/15 ₹0.15
Net earning ₹0.05
Initial investment ₹10.00
Rate of earning (Monthly) 0.5%
Rate of earning (Annual) 6.00%
Question 21
On 1-4-2012 ABC Mutual Fund issued 20 lakh units at ₹10 per unit. Relevant initial expenses
involved were ₹12 lakhs. It invested the fund so raised in capital market instruments to build a
portfolio of ₹ 185 lakhs. During the month of April 2012, it disposed off some of the instruments
costing ₹60 lakhs for ₹63 lakhs and used the proceeds in purchasing securities for ₹56 lakhs.
Fund management expenses for the month of April 2012 was ₹8 lakhs of which 10% was in
arrears. In April 2012 the fund earned dividends amounting to ₹2 lakhs and it distributed 80% of
the realized earnings. On 30-4-2012 the market value of the portfolio was ₹198 lakhs.
Mr. Akash, an investor, subscribed to 100 units on 1-4-2012 and disposed off the same at closing
NAV on 30-4-2012. What was his annual rate of earning?
May 13 (8 Marks), RTP Nov 14, RTP May 18, MTP Mar 19 (Old) (5 Marks), RTP May 20 (Old), Practice Manual
Answer:
Amount in Amount in Amount in
₹ lakhs ₹ lakhs ₹ lakhs
Opening Bank (200 - 185 -12) 3.00
Add: Proceeds from sale of securities 63.00 68.00
Add: Dividend received 2.00
295
Deduct:
Cost of securities purchased 56.00
Fund management expenses paid (90% of 8) 7.20
Capital gains distributed = 80% of (63 – 60) 2.40
Dividend distributed = 80% of 2.00 1.60 67.20
Closing Bank 0.80
Closing market value of portfolio 198.00
198.80
Less: Arrears of expenses 0.80
Closing Net Assets 198.00
Number of units (Lakhs) 20
Closing NAV per unit 9.90
Rate of Earning (Per Unit)

Amount
Income received (₹2.40 + ₹1.60)/20 ₹0.20
Loss: Loss on disposal (₹200 - ₹198)/20 ₹0.10
Net earning ₹0.10
Initial investment ₹10.00
Rate of earning (monthly) 1%
Rate of earning (Annual) 12%
Question 22
A mutual fund made an issue of 10,00,000 units of ₹10 each on January 01, 2008. No entry load
was charged. It made the following investments:
Particulars ₹
50,000 Equity shares of ₹100 each @ ₹160 80,00,000
7% Government Securities 8,00,000
9% Debentures (Unlisted) 5,00,000
10% Debentures (Listed) 5,00,000
98,00,000
296
During the year, dividends of ₹12,00,000 were received on equity shares. Interest on all types
of debt securities was received as and when due. At the end of the year equity shares and 10%
debentures are quoted at 175% and 90% respectively of face value. Other investments are at
par.
Find out the Net Asset Value (NAV) per unit given that operating expenses paid during the year
amounted to ₹5,00,000. Also find out the NAV, if the Mutual fund had distributed a dividend of
₹0.80 per unit during the year to the unit holders.
Nov 09 (8 Marks), MTP Feb 14 (6 Marks), MTP Feb 15 (8 Marks), RTP May 17,
RTP May 18 (Old), Practice Manual, StudyMat
Answer:
In order to find out the NAV, the cash balance at the end of the year is calculated as follows-
Particulars ₹
Cash balance in the beginning
(₹100 lakhs – ₹98 lakhs) 2,00,000
Dividend Received 12,00,000
Interest on 7% Govt. Securities 56,000
Interest on 9% Debentures 45,000
Interest on 10% Debentures 50,000
15,51,000
(-) Operating expenses 5,00,000
Net cash balance at the end 10,51,000
Calculation of NAV ₹
Cash Balance 10,51,000
7% Govt. Securities (at par) 8,00,000
50,000 equity shares @ ₹175 each 87,50,000
9% Debentures (Unlisted) at cost 5,00,000
10% Debentures @90% 4,50,000
Total Assets 1,15,51000
No. of Units 10,00,000
NAV per Unit ₹11.55
297
Calculation of NAV, if dividend of ₹0.80 is paid –

Net Assets (₹1,15,51,000 – ₹8,00,000) ₹1,07,51,000
NAV per unit ₹10.75
Question 23
Cinderella Mutual Fund has the following assets in Scheme Rudolf at the close of business on
31st March, 2014.
Company No. of Shares Market Price Per Share
Nairobi Ltd. 25000 ₹20
Dakar Ltd. 35000 ₹300
Senegal Ltd. 29000 ₹380
Cairo Ltd. 40000 ₹500
The total number of units of Scheme Rudol fare 10 lacs. The Scheme Rudolf has accrued
expenses of ₹2,50,000 and other liabilities of ₹2,00,000. Calculate the NAV per unit of the
Scheme Rudolf.
MTP April 2021 (8 Marks), Nov 14 (4 Marks), MTP Oct 18 (New) (5 Marks), Practice Manual, StudyMat
Answer:
Shares No. of shares Price Amount (₹)
Nairobi Ltd. 25,000 20.00 5,00,000
Dakar Ltd. 35,000 300.00 1,05,00,000
Senegal Ltd. 29,000 380.00 1,10,20,000
Cairo Ltd. 40,000 500.00 2,00,00,000
4,20,20,000
Less: Accrued Expenses 2,50,000
Other Liabilities 2,00,000
Total Value 4,15,70,000
NAV per Unit (4,15,70,000/10,00,000) 41.57
298
Question 24
ACE Mutual Fund has the following assets under it on the close of business as on:
1st August, 2019 2nd August, 2019
Company No. of Shares
Market Price Per Share ₹ Market Price Per Share ₹
Q Ltd. 2,000 200.00 205.00
R Ltd. 30,000 312.40 360.00
S Ltd. 40,000 180.60 191.55
T Ltd. 60,000 505.10 503.90
Total No. of Units issued by the Mutual Fund is 6,00,000.

(i) Calculate Net Assets Value (NAV) per Unit as on 1st August, 2019.
(ii) Following information is also given:
Assuming that Mr. Tarun, submits a cheque of ₹30,00,000 to the Mutual Fund and the
Fund Manager of this entity purchases 8,000 shares of R Ltd and the balance amount is
held in Bank. In such a situation, what would be the position of the Fund?
(iii) Find new NAV per Unit as on 2nd August, 2019.
MTP March 22 (8 Marks), Nov 20 (Old) (8 Marks), RTP Nov 13, MTP April 18 (Old) (8 Marks), May 12 (8
Marks), May 18 (New) (10 Marks), RTP Nov 11, MTP Feb 16 (8 Marks), Practice Manual, StudyMat
Answer:
(i) NAV of the Fund
₹4,00,000+₹93,72,000+₹72,24,000+₹3,03,06,000
=
6,00,000
₹4,73,02,000
=
6,00,000
= ₹78.8366 rounded to ₹78.84 per unit
(ii) The revised position of fund shall be as follows:

Q Ltd. 2,000 200.00 4,00,000
R Ltd. 38,000 312.40 1,18,71,200
S Ltd. 40,000 180.60 72,24,000
T Ltd. 60,000 505.10 3,03,06,000
Cash 5,00,800
5,03,02,000
299
Cash = 30,00,000 - 8000*312.40 = 5,00,800

30,00,000
No. of units of fund = 6,00,000 + = 6,38,052
78.84
(iii) On 2nd August 2019, the NAV of fund will be as follows:

Q Ltd. 2,000 205.00 4,10,000
R Ltd. 38,000 360.00 1,36,80,000
S Ltd. 40,000 191.55 76,62,000
T Ltd. 60,000 503.90 3,02,34,000
Cash 5,00,800
5,24,86,800
₹5,24,86,800
NAV as on 2nd August 2019 = = ₹82.26 per unit
6,38,052
Question 25
Based on the following data, estimate the Net Asset Value (NAV) on per unit basis of a Regular
Income Scheme of a Mutual Fund on 31-3-2015:
₹(in lakhs)
Listed Equity shares at cost (ex-dividend) 40.00
Cash in hand (As on 1-4-2014) 5.00
Bonds & Debentures at cost 8.96
Of these, Bonds not listed & not quoted 2.50
Other fixed interest securities at cost 9.75
Dividend accrued 1.95
Amount payable on shares 13.54
Expenditure accrued 1.76
Current realizable value of fixed income securities of face value of ₹100 is = ₹96.50
Number of Units (₹10 face value each): = 275000
Listed equity shares were purchased at a time when market portfolio index was = 12,500
On NAV date, the market portfolio index is at = 19,975
There has been a diminution of 15% in unlisted bonds and debentures valuation.
Listed bonds and debentures carry a market value of ₹7.5 lakhs, on NAV date.
Operating expenses paid during the year amounted to ₹2.24 lakhs.
May 14 (8 Marks), MTP Aug 18 (Old) (8 Marks), MTP Oct 15 (8 Marks), RTP Nov 16, Practice Manual
300
Answer:
Particulars Adjustment Value
₹lakhs
Equity Shares 63.920
Cash in hand (5.000 – 2.240) 2.760
Bonds and debentures not listed 2.125
Bonds and debentures listed 7.500
Dividends accrued 1.950
Fixed income securities 9.409
Sub total assets (A) 87.664

Sub total liabilities (B) 15.30
Net Assets Value (A) – (B) 72.364
No. of units 2,75,000
Net Assets Value per unit (₹72.364 lakhs / 2,75,000) ₹26.3142
Question 26
Based on the following information, determine the NAV of a regular income scheme on per unit
basis:
Particulars ₹ Crores
Listed shares at Cost (ex-dividend) 20
Cash in hand 1.23
Bonds and debentures at cost 4.3
Of these, bonds not listed and quoted 1
Other fixed interest securities at cost 4.5
Dividend accrued 0.8
Number of units (₹10 face value) 20 lacs
Current realizable value of fixed income securities of 106.5
face value of ₹100
301
The listed shares were purchased when Index was 1,000

Present index is 2,300
Value of listed bonds and debentures at NAV date 8
There has been a diminution of 20% in unlisted bonds and debentures. Other fixed interest
securities are at cost.
May 16 (6 Marks), May 2010 (6 Marks), MTP April 22 (8 Marks), RTP Nov 2018 (New)
Answer:
Particulars Adjusted Values
₹crores
Equity Shares 46.00
Cash in hand 1.23
Bonds and debentures not listed 0.80
Bonds and debentures listed 8.00
Dividends accrued 0.80
Fixed income securities 4.50
Sub total assets (A) 61.33
Less: Liabilities
Sub total liabilities (B) 7.07
Net Assets Value (A) – (B) 54.26
Net Assets Value per unit (₹54.26 crore / 20,00,000) ₹271.30
Question 27
The following particulars relating to Vishnu Fund Schemes:
Particulars Value ₹
in Crores
1. Investment in Shares (at cost)
a. Pharmaceuticals companies 79
b. Construction Industries 31
c. Service Sector Companies 56
302
d. IT Companies 34
e. Real Estate Companies 10
2. Investment in Bonds (Fixed Income)
a. Listed Bonds (8000, 14% Bonds of ₹15,000 each) 12
b. Unlisted Bonds 7
3. No. of Units outstanding (crores) 4.2
4. Expenses Payable 3.5
5. Cash and Cash equivalents 1.5
6. Market expectations on listed bonds 8.842%
Particulars relating to each sector are as follows:

Sector Index on Purchase date Index on Valuation date
Pharmaceutical companies 260 465
Construction Industries 210 450
Service Sector Companies 275 480
IT Companies 240 495
Real Estate Companies 255 410
The fund has incurred the following expenses:

Consultancy and Management fees ₹480 Lakhs
Office Expenses ₹150 Lakhs
Advertisement Expenses ₹38 Lakhs

(i) Net Asset Value of the fund
(ii) Net Asset Value per unit
(iii) If the period of consideration is 2 years, and the fund has distributed ₹3 per unit per year
as cash dividend, ascertain the Net return (Annualized).
(iv) Ascertain the Expenses ratio.
May 19 (Old) (5 Marks)
Answer:
303
(i) Calculation of NAV of the Fund

Crore ₹
Value of Shares
a. Pharmaceutical Companies 465 141.288

79 ×
260
b. Construction Companies 450 66.429

31 ×
210
c. Service Sector Companies 480 97.745

56 ×
275
d. IT Companies 495 70.125

34 ×
240
e. Pharmaceutical Companies 410 16.078

10 ×
255
Investment in Bonds
a. Listed Bonds 14 19.00

× 12
8.842
b. Unlisted Bonds 7.000
Cash and Cash Equivalents 1.50
419.165
Less: Expense Payable 3.500
NAV of the Fund 415.665
(ii) NAV of the Fund Per Unit

NAV of the Fund ₹415.665 crore
Number of Units 4.20 crore
NAV Per Unit (₹415.665 crore/ 4.20 crore) ₹98.97
(iii) Net Return

Initial Cost Per Unit
Investment in Shares ₹210 crore
Bonds ₹19 crore ₹229 crore
Cost Per Unit ₹54.52
Return
304
Capital Gain (₹98.97 – ₹54.52) ₹44.45

Dividend ₹3 × 2 ₹6.00
₹50.45
Annualised Return 50.45 1 46.27%
×
54.52 2
(iv) Expense Ratio

480+150+38
Expense per unit 420 1.5950
= × 100 = × 100 = × 100 = 1.607%
NAV per unit 98.97 98.97
Question 28
The following particulars relating to S Fund Schemes:
Particulars Value ₹ in Crores
1. Investment in Shares (at cost)
a. Pharmaceuticals companies 158
b. Construction Industries 62
c. Service Sector Companies 112
d. IT Companies 68
e. Real Estate Companies 20
2. Investment in Bonds (Fixed Income)
a. Listed Bonds (8000, 14% Bonds of ₹15,000 each) 24
b. Unlisted Bonds 14
3. No. of Units outstanding (crores) 8.4
4. Expenses Payable 7
5. Cash and Cash equivalents 3
6. Market expectations on listed bonds 8.842%
The fund has incurred the following expenses:

Consultancy and Management fees ₹520 Lakhs
Office Expenses ₹180 Lakhs
Advertisement Expenses ₹48 Lakhs
305
Particulars relating to each sector are as follows:

Sector Index on Purchase date Index on Valuation date
Pharmaceutical companies 300 500
Construction Industries 275 490
Service Sector Companies 285 500
IT Companies 270 515
Real Estate Companies 265 440
Required:
(i) Calculate the Net Asset Value of the fund
(ii) Calculate the Net Asset Value per unit
(iii) Determine the Net return (Annualized), if the period of consideration is 4 years, and the fund
has distributed ₹2 per unit per year as cash dividend during the same period.
Note: Calculate figure in ₹Crore upto 3 decimal points.
RTP May 21 (New), RTP May 21 (Old)
Answer:
(i) Calculation of NAV of the Fund
(in ₹ Crore)
1. Value of Shares
a. Pharmaceutical Companies 158 × 500 263.333
300
b. Construction Companies 490 110.473

62 ×
275
c. Service Sector Companies 500 196.491

112 ×
285
d. IT Companies 515 129.704

68 ×
270
e. Real Estate Companies 440 33.208

20 ×
265
2. Investment in Bonds
a. Listed Bonds 14 38.00
× 24
8.842
b. Unlisted Bonds 14.000

3. Cash and Cash Equivalents 3.00
306
788.209
Less: Expense Payable 7.000
NAV of the Fund 781.209
(ii) NAV of the Fund per Unit

NAV of the Fund ₹781.209 crore
NAV Per Unit (₹781.209 crore/ 8.40 crore) ₹93.00
(iii)Net Return
Initial Cost Per Unit
Investment in Shares ₹420 crore
Bonds ₹38 crore ₹458 crore
Cost Per Unit ₹54.52
Return
Capital Gain (₹93.00 - ₹54.52) ₹38.48
Dividend ₹4 × 2 ₹8.00
₹46.48
Annualised Return 46.48 1 21.31%
×
54.52 4
Question 29
Based on the following data, estimate the Net Asset Value (NAV) 1st July 2016 on per unit
basis of a Debt Fund:
Name of Face Purchas Maturity Date No. of Coupon Duration
Security Value ₹ e Price Securities Date(s) of Bonds
10.71% 100 104.78 31st March, 100000 31st March 7.3494
GOI 2028 2028
10% 100 100.00 31st 50000 31st March & 5.086
GOI 2023 March,2023 30th September
9.5% 100 97.93 31st December, 40000 30th June & 4.3949
GOI 2021 2021 31st December
8.5% 100 91.36 30th June, 2025 20000 30th June 6.5205
SGL 2025
307
Number of Units (₹10 face value each): 100000

All securities were purchased at a time when applicable Yield to Maturity (YTM) was 10%.
On NAV date, the required yield increased by 75 basis point and Cash in hand and accrued
expenses were ₹6,72,800 and ₹2,37,400 respectively.
MTP Oct 17, RTP Nov 17
Answer:
Working Note:
(i) Calculation of Interest Accrued
Name of Security Maturity Date Amount (₹)
10.71% GOI 2028 100 × 100000 × 10.71% × 3 2,67,750
12
10% GOI 2023 3 1,25,000

100 × 50000 × 10.00% ×
12
Total 3,92,750
Note: Interests on two remaining securities shall not be considered as last interest
was paid on 30.06.2016
(ii) Valuation of Securities

Name of Purchase Duration Volatility (%) (+)/(-) Total
Security Amount ₹ of Bonds Amount
10.71% 1,04,78,000 7.3494 7.3494 - 99,52,947
GOI 2028 × 0.75 = 5.01105,25,053
1.10
10% GOI 50,00,000 5.086 5.086 - 48,18,355
2023 × 0.75 = 3.6329 1,81,645
1.05
9.5% GOI 39,17,200 4.3949 4.3949 - 37,94,231
2021 × 0.75 = 3.13921,22,969
1.05
8.5% SGL 18,27,200 6.5205 6.5205 -81,230 17,45,970
2025 × 0.75 = 4.4456
1.10
2,03,11,503
308
(iii) Calculation of NAV

Particulars ₹ crores
Value of Securities as computed above 2,03,11,503
Cash in hand 6,72,800
Interest accrued 3,92,750
Sub total assets (A) 2,13,77,053
Less: Liabilities
Expenditure accrued 2,37,400
Sub total Liabilities (B) 2,37,400
Net Asset Value (A) – (B) 2,11,39,653
Net Assets Value per unit (₹2,11,39,653/1,00,000) ₹211.40
Question 30
M/s. Strong an AMC has floated a dividend bonus plan on 1st April, 2016 at a certain net asset
value (NAV). The fund has a robust growth and has declared a bonus of 1: 5 (1 bonus unit for 5
right units held) on 30th September 2017 and a second bonus of 1 : 4 (1 bonus unit for 4 right
units held) on 30th September 2019.The fund, as on 31st March 2021, has generated an
average yield of 17.5%.
Mr. Optimistic has made an investment of ₹15 lakhs in the plan before the declaration of the first
bonus and remain invested thereafter.
The following information is also available:
Period (t) 01.04.2016 30.09.2017 30.09.2019 31.03.2021
NAV (₹) ? 85 92 100
You are required to advice to Mr. Optimistic the opening NAV, which is required by him to
calculate the capital appreciation. July 21 (Old) (4 Marks)
Answer:
Particulars
(a) Amount invested by Mr. Optimistic as on 01/04/2016 ₹16,00,000
(b) Gain during 5 years (16,00,000 × 17.5% × 5 years) ₹14,00,000
(c) Value of investment as on 31/03/2021 (a + b) ₹30,00,000
(d) NAV as on 31/03/2021 ₹100 per Unit
(e) Total number of units as on 31/03/2021 (c/d) 30000 Units
Total units before second bonus = 30,000 × 4/5 24000 Units
Total units before first bonus = 24,000 × 5/6 20000 Units
NAV as on 01/04/2016 = 16,00,000/ 20000 ₹80 per Unit
309
Question 31
Mr. X on 1.7.2015, during the initial offer of some Mutual Fund invested in 10,000 units having
face value of ₹10 for each unit. On 31.3.2016, the dividend paid by the M.F. was 10% and Mr.
X found that his annualized yield was 153.33%. On 31.12.2017, 20% dividend was given. On
31.3.2018, Mr. X redeemed all his balance of 11,296.11 units when his annualized yield was
73.52%. What are the NAVs as on 31.3.2016, 31.3.2017 and 31.3.2018?
MTP Mar 17 (8 Marks), RTP May 19 (Old), Practice Manual
Answer:
Yield for 9 months = (153.33 × 9/12) = 115%
Market value of Investments as on 31.03.2016 = 1, 00,000/- + (1, 00,000 × 115%)
= ₹2,15,000/-
Therefore, NAV as on 31.03.2016 = (2,15,000-10,000)/10,000
= ₹20.50
(NAV would stand reduced to the extent of dividend payout, being (10,000 × 10 × 10%) =
₹10,000)
Since dividend was reinvested by Mr. X, additional units acquired =
₹10,000
= 487.80 units
₹20.50
Therefore, units as on 31.03.2016 = 10,000 + 487.80 = 10,487.80
[Alternately, units as on 31.03.2016 = (2,15,000/20.50) = 10,487.80]
Dividend as on 31.03.2017 = 10,487.80 × 10 × 0.2 = ₹20.975.60
Let X be the NAV on 31.03.2017, then number of new units reinvested will be ₹20,975.60/X.
Accordingly 11296.11 units shall consist of reinvested units and 10487.80 (as on
31.03.2016). Thus, by way of equation it can be shown as follows:
20975.60
11296.11 = +10487.80
X
Therefore, NAV as on 31.03.2017 = 20,975.60/(11,296.11 - 10.487.80)
= ₹25.95
NAV as on 31.03.2018 = ₹1,00,000 (1 + 0.7352 × 33/12)/11296.11
= ₹26.75
310
Question 32
Mr. X on 1.7.2012, during the initial public offer of a Mutual Fund (MF) invested ₹1,00,000 at
Face Value of ₹10. On 31.3.2013, the MF declared a dividend of 10% when Mr. X calculated
that his holding period return was 115%. On 31.3.2014, MF again declared a dividend of 20%.
On 31.3.2015, Mr. X redeemed all his investment which had accumulated to 11,296.11 units
when his holding period return was 202.17%.
Calculate the NAVs as on 31.03.2013, 31.03.2014 and 31.03.2015.
Nov 15 (8 Marks), MTP Mar 17 (8 Marks), RTP May 19 (Old), Practice Manual, StudyMat
Answer:
Yield for 9 months = 115%
Market value of Investments as on 31.03.2013 = 1,00,000/- + (1,00,000 × 115%)
= ₹2,15,000/-
Therefore, NAV as on 31.03.2013 = (2,15,000 -10,000)/10,000
= ₹20.50
(NAV would stand reduced to the extent of dividend payout, being (₹100,000 × 10%)
= ₹10,000)
Since dividend was reinvested by Mr. X,

₹10,000
additional units acquired = = 487.80 units
₹20.50
Therefore, units as on 31.03.2013 = 10,000+ 487.80 = 10,487.80
[Alternately, units as on 31.03.2013 = (2,15,000/20.50) = 10,487.80
Dividend as on 31.03.2014 = 10,487.80 × 10 × 0.2 = ₹20,975.60
Accordingly 11296.11 units shall consist of reinvested units and 10487.80 (as on
31.03.2013). Thus, by way of equation it can be shown as follows:
20975.60
11296.11 = + 10487.80
X
Therefore, NAV as on 31.03.2014 = 20,975.60/(11,296.11- 10,487.80) = ₹25.95
NAV as on 31.03.2015 = ₹1,00,000 (1+2.0217)/11296.11 = ₹26.75
311
Question 33
A reputed financial institution of the country floated a Mutual fund having a corpus of ₹10 crores
consisting of 1 crore units of ₹10 each. Mr. Vijay invested ₹10,000 for 1000 units of ₹10 each on
1st July 2014. For the financial year ended 31st March 2015, the fund declared a dividend of
10% and Mr. Vijay found that his annualized yield from the fund was 153.33%. The mutual fund
during the financial year ended 31st March 2016, declared a dividend of 20%. Mr. Vijay has
reinvested the entire dividend in acquiring units of this mutual fund at its appropriate NAV.
On 31st march 2017 Mr. Vijay redeemed all his balances of 1129.61 units when his annualized
yield was 73.52%.
You are required to find out NAV as on 31st March 2015, 31st March 2016 and 31st March 2017.
Nov 15 (8 Marks), Nov 17 (8 Marks), Practice Manual
Answer:
Yield for 9 months = (153.33 × 9/12) = 115%
Market value of Investments as on 31.03.2015 = 10,000/- + (10,000 × 115%)
= ₹21,500/-
Therefore, NAV as on 31.03.2015 = (21,500 – 1,000)/1,000
= ₹20.50
(NAV would stand reduced to the extent of dividend payout, being (₹1,000 × 10 × 10%) =
₹1,000)
₹1,000
Since dividend was reinvested by Mr. X, additional units acquired = = 48.78 units
₹20.50
Therefore, units as on 31.03.2015 = 1,000 + 48.78 = 1048.78

[Alternately, units as on 31.03.2015 = (21,500/20.50) = 1048.78]
Dividend as on 31.03.2016 = 1048.78 × 10 × 0.2 = ₹2,097.56
Let X be the NAV on 31.03.2016, then number of new units reinvested will be ₹2097.56/X.
Accordingly 1129.61 units shall consist of reinvested units and 1048.78 (as on 31.03.2015).
2097.56
Thus, by way of equation it can be shown as follows:1129.61 = +1048.78
X
Therefore, NAV as on 31.03.2016 = 20,97.56/ (1,129.61 - 1,048.78) = ₹25.95

NAV as on 31.03.2017 = ₹10,000 (1 + 0.7352 × 33/12) / 1129.61 = ₹26.75
312
Question 34
On 01-07-2016, Mr. X Invested ₹50,000/- at initial offer in Mutual Funds at a face value of ₹10
each per unit. On 31-03-2017, a dividend was paid @10% and annualized yield was 120%. On
31-03-2018, 20% dividend and capital gain of ₹0.60 per unit was given. Mr. X redeemed all his
6271.98 units when his annualized yield was 71.50% over the period of holding. Calculate NAV
as on 31-03-2017, 31-03-2018 and 31-03-2019.
For calculations consider a year of 12 months.
Nov 13 (5 Marks), RTP May 20 (New), Practice Manual
Answer:
Yield for 9 months (120% × 9/12) = 90%
Market value of Investments as on 31.03.2017 = ₹50,000/- + (₹50,000 × 90%)
= ₹95,000/
Therefore, NAV as on 31.03.2017 = (₹95,000 - ₹5,000)/5,000 = ₹18.00

₹5,000
Since dividend was reinvested by Mr. X, additional units acquired = = 277.78 unit
₹18
Therefore, units as on 31.03.2017 = 5,000 + 277.78 = 5,277.78
Alternatively, units as on 31.03.2017 = (₹95,000/₹18) = 5,277.78
Dividend as on 31.03.2018 = 5,277.78 × ₹10 × 0.2
= ₹10,555.56
Capital Gain (5277.78 × ₹0.60) = ₹3,166.67
= ₹13,722.23
Accordingly, 6,271.98 units shall consist of reinvested units and 5277.78 (as on 31.03.2017).
Thus, by way of equation it can be shown as follows:
₹13,722.23
6271.98 = +5277.78
X
Therefore, NAV as on 31.03.2018 = ₹13,722.23/(6,271.98 – 5,277.78) = ₹13.80
NAV as on 31.03.2019 = ₹50,000 (1 + 0.71 5 × 33/12)/6,271.98 = ₹23.65
313
Question 35
There are two Mutual Funds viz. D Mutual Fund Ltd. and K Mutual Fund Ltd. Each having close
ended equity schemes.
NAV as on 31-12-2014 of equity schemes of D Mutual Fund Ltd. is ₹70.71 (consisting 99%
equity and remaining cash balance) and that of K Mutual Fund Ltd. is 62.50 (consisting 96%
equity and balance in cash).
Following is the other information:
Particular Equity Schemes
D Mutual Fund Ltd. K Mutual Fund Ltd.
Sharpe Ratio 2 3.3
Treynor Ratio 15 15
Standard deviation 11.25 5
There is no change in portfolios during the next month and annual average cost is ₹3 per unit
for the schemes of both the Mutual Funds.
If Share Market goes down by 5% within a month, calculate expected NAV after a month for
the schemes of both the Mutual Funds.
For calculation, consider 12 months in a year and ignore number of days for particular month.
Dec 21 (New) (8 Marks), MTP Nov 21 (New) 10 Marks, MTP Nov 21 (Old) 10 Marks, May 15 (8 Marks), RTP
May 19 (New), MTP Mar 18 (Old) (8 Marks), RTP Nov 20 (New), RTP Nov 20 (Old), Practice Manual
Answer:
Working Notes:
(i) Decomposition of Funds in Equity and Cash Components
NAV on 31.12.14 ₹70.71 ₹62.50
% of Equity 99% 96%
Equity element in NAV ₹70 ₹60
Cash element in NAV ₹0.71 ₹2.50
(ii) Calculation of Beta

(a) D Mutual Fund Ltd.
EሺRሻ-Rf EሺRሻ-Rf
Sharpe Ratio = 2 = =
σD 11.25
E(R) - Rf = 22.50
314
EሺRሻ-Rf 22.50
Treynor Ratio = 15 = =
βD βD
βD = 22.50/ 15 = 1.50
(b) K Mutual Fund Ltd.

Sharpe Ratio = 3.3 = =
σK 5
E(R) - Rf = 16.50
EሺRሻ-Rf 16.50
βk βk
βD = 16.50/ 15 = 1.10
(iii) Decrease in the Value of Equity

Market goes down by 5.00% 5.00%
Beta 1.50 1.10
Equity component goes down 7.50% 5.50%
(iv) Balance of Cash after 1 month

Cash in Hand on 31.12.14 ₹0.71 ₹2.50
Less: Exp. Per month ₹0.25 ₹0.25
Balance after 1 month ₹0.46 ₹2.25
NAV after 1 month

Value of Equity after 1 month
70 × (1 - 0.075) ₹ 64.75 -
60 × (1 - 0.055) - ₹ 56.70
Cash Balance 0.46 2.25
65.21 58.95
315
Question 36
Following are the details of closely ended schemes of two mutual funds as on 31/08/2021:
Particular
AJ Mutual Fund RP Mutual Fund
NAV (p.u.) ₹80 (Consisting 95% ₹61 (Consisting ₹60
equity & remaining equity & remaining
cash balance) cash balance)
Sharpe Ratio 1.5 3
Treynor Ratio 12 10
Standard deviation 10 6
There is no change in portfolios during the September month.

Monthly cost is ₹0.50 per unit for each mutual fund scheme.
Share market rose by 2% in the month of September.
You are required to calculate expected NAV p.u. as on 30/09/2021 for both schemes.
Dec 21 (New) (8 Marks), Dec 21 (Old) (8 Marks), MTP Nov 21 (New) 10 Marks, MTP Nov 21 (Old) 10 Marks,
May 15 (8 Marks), RTP May 19 (New), MTP Mar 18 (Old) (8 Marks), RTP Nov 20 (New), RTP Nov 20 (Old),
Practice Manual
Answer:
(i) Decomposition of Funds in Equity and Cash Components
NAV on 31.08.21 ₹80.00 ₹61.00
% of Equity 95% 98.36%
Equity element in NAV ₹76.00 ₹60.00
Cash element in NAV ₹4.00 ₹1.00
(ii) Calculation of Beta

(a) AJ Mutual Fund
Sharpe Ratio = 1.5= =
σA,J 10
E(R) – Rf = 15
EሺRሻ-Rf 15
βA,J βA,J
ΒA,J = 15.00/12 = 1.25
316
(b) RP Mutual Fund
Sharpe Ratio = 3= =
σ𝑅,𝑃 6
E(R) – Rf = 18
EሺRሻ-Rf 18
βR,P βR,P
ΒK = 18/10 = 1.80
(iii) Increase in the Value of Equity

Market rose by 2.00% 2.00%
Beta 1.25 1.80
Equity component goes up 2.50% 3.60%
(iv) Balance of Cash after 1 month

Cash in Hand on 30.09.21 ₹4.00 ₹1.00
Less: Exp. Per month ₹0.50 ₹0.50
Balance after 1 month ₹3.50 ₹0.50
NAV after 1 month

Value of Equity after 1 month
76 × (1 + 0.025) ₹77.90 -
60 × (1 + 0.036) - ₹62.16
Cash Balance ₹3.50 ₹0.50
NAV ₹81.40 ₹62.66
317
Question 37
ANP Plan, a hedge fund currently has assets of ₹20 crore. CA. X, the manager of fund charges
fee of 0.10% of portfolio asset. In addition to it he charges incentive fee of 2%. The incentive
will be linked to gross return each year in excess of the portfolio maximum value since the
inception of fund. The maximum value the fund achieved so far since inception of fund about
one and half year ago was ₹21 crores.
You are required to compute the fee payable to CA. X, if return on the fund this year turns out to
be
(a) 29%
(b) 4.5%
(c) -1.8%
RTP Nov 19 (Old), Practice Manual
Answer:
(a) If return is 29%
₹
Fixed fee (A) 0.10% of ₹20 crore 2,00,000
New Fund Value (1.29 × ₹20 crore) 25.80 crore
Excess Value of best achieved (25.8 crore – 21.0 crore) 4.80 crore
Incentive Fee (2% of 4.80 crores) (B) 9,60,000
Total Fee (A)+(B) 11,60,000
(b) If return is 4.5%

₹
Fixed (A) 0.10% of ₹20 crore 2,00,000
New Fund Value (1.045 × ₹20 crore) 20.90 crore
Excess Value of best achieved (20.90 crore – 21.00 crore) (₹0.10 crore)
Incentive Fee (as does not exceed best achieved) (B) Nil
Total Fee (A)+(B) 2,00,000
(c) If return is (-1.8%)

No incentive only fixed fee of ₹2,00,000 will be paid
318
Question 38
Blue Tooth Mutual Fund is planning to float a fixed income fund of ₹100 crores on 1 January
2015 with a term of 7 years. If the target duration of fund is 5½ years and has expected rate of
return of 8.00%, then determine the amount of interest it has to earn annually on its investment
after defraying management expenses of 10% of amount income earned.
Answer:
Let annual inflow after defraying management expenses be x. Then
Period Inflow PVF @ 8% Year PVF X Inflow PV × Years
2015 x 0.926 1 0.926x 0.926x
2016 x 0.857 2 0.857x 1.714x
2017 x 0.794 3 0.794x 2.382x
2018 x 0.735 4 0.735x 2.94x
2019 x 0.681 5 0.681x 3.405x
2020 x 0.630 6 0.630x 3.78x
2021 x 0.583 7 0.583x 4.081x
2021 100 0.583 7 58.3 408.10
5.206x + 58.3 19.228x + 408.10
19.228x+408.10
= 5.5
5.206x +58.30
19.228x + 408.10 = 28.633x + 320.65

9.405x = 87.45
x = 9.31 i.e. 9.31% (Post Management Expenses)
9.31
Return before management expenses = = 10.34%
0.90
Question 39
On 1st January, 2020 an open ended scheme of mutual fund had outstanding units of 300 lakhs
with a NAV of ₹20.25. At the end of January 2020, it had issued 5 lakhs units at an opening NAV
plus a load of 2%, adjusted for dividend equalisation. At the end of February 2020, it had
repurchased 2.5 lakhs units at an opening NAV less 2% exit load adjusted for dividend
equalisation. At the end of March 2020, it had distributed 70 per cent of its available income.
In respect of January – March quarter, the following additional information is available:
319
Value appreciation of the portfolio ₹460 lakhs

Income for January ₹24 lakhs
Income for February ₹36 lakhs
Income for March ₹47 lakhs

(i) Income available for distribution
(ii) Issue price at the end of January
(iii) Repurchase price at the end of February
(iv) Closing value of Net Assets at the end of March
Jan 21 (New) (8 Marks), Jan 21 (Old) (8 Marks), Nov 15 (8 Marks), MTP Aug 18 (New) (8 Marks), RTP
Nov 18 (Old), RTP Nov 19 (Old), MTP Apr 19 (New) (8 Marks), RTP May 19 (Old), RTP May 22
Answer:
(i) Calculation of Income Available for Distribution
Units Per Unit Total
(Lakh) (₹) (₹ In lakh)
Income from January 300 0.0800 24.0000
Add: Dividend equalization collected on issue 5 0.0800 0.4000
305 0.0800 24.4000
Add: Income from February 0.1180 36.0000
305 0.1980 60.4000
Less: Dividend equalization paid on repurchase 2.50 0.1980 (0.4950)
302.50 0.1980 59.9050
Add: Income from March 0.1554 47.0000
302.50 0.3534 106.9050
Less: Dividend Paid 0.2474 (74.8335)
302.50 0.1060 32.0715
(ii) Calculation of Issue Price at the end of January

₹
Opening NAV 20.250
Add: Entry Load 2% of ₹20.25 0.405
20.655
Add: Dividend Equalization collected on Issue Price 0.080
20.735
320
(iii) Calculation of Repurchase Price at the end of February

₹
Opening NAV 20.250
Less: Exit Load 2% of ₹20.250 (0.405)
19.845
Add: Dividend Equalization paid on Issue Price 0.198
20.043
(iv) Closing NAV at the end of March

₹ (lakh)
Opening Net Asset Value (₹20.25 × 300) 6075.000
Portfolio Value Appreciation 460.000
Issue of Fresh Units (5 × 20.735) 103.675
Income Received (24 + 36 + 47) 107.000
Less: Units repurchased (2.5 × 20.043) - 50.1075 6745.675
Income Distributed -74.8335 (-124.941)
Closing Net Asset Value 6620.734
Closing Units (300 + 5 – 2.5) lakh 302.50 lakh
Closing NAV as on 31st March ₹21.8867
Question 40
The Asset Management Company of the mutual fund (MF) has declared a dividend of 9.98% on
the units under the dividend reinvestment plan for the year ended 31st March, 2021. The
investors are issued additional units for the dividend at the rate of closing Net Asset Value (NAV)
for the year as per the conditions of the scheme. The closing NAV was ₹24.95 as on 31st March,
2021. An investor Mr. X who is having 20,800 units at the year-end has made an investment in
the units before the declaration of the dividend and at the rate of opening NAV plus an entry load
of ₹0.04. The NAV has appreciated by 25% during the year.
Assume the face value of the unit as ₹10.00.
(i) Opening NAV,
(ii) Number of the units purchased,
(iii) Original amount of the investment.
Answer:
321
(i) Let N be the opening NAV, then

N (1 + 0.25) = ₹24.95
N = ₹19.96
i.e., beginning NAV = ₹19.96
(ii) Let X be the number of units purchased

Then ending units = 20,800
Accordingly,
0.998X
20800 = X +
24.95
24.05X + 0.998X
20800=
24.95
X = 20000
Thus, number of units to be purchased = 20,000
(iii) Original amount of investment

Initial NAV ₹19.96
Entry Load ₹0.04
₹20.00
Number of funds purchased 20,000
Amount of Investment ₹4,00,000
322
Notes
323
CA Mayank Kothari is a member of The Institute of
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He has qualified Chartered Accountancy exam in

May 2012 at the age of 22 with All India 47th Rank
He has received Gold Medal and Felicitated

with the Best Student Award
He has worked with Deloitte, Haskins &

Sells, Pune
He has taught more than 30000

Students since 2016 in Video
Lectures
He has founded Conferenza.in

platform in 2017 for Online Classes
and Books
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33 Past Exam Papers (May 2008 to May 2022)

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Volatility in terms of Rupee is

(a) Weekly (250/50)

(b) Monthly (250/12)

(c) Semi Annual (250/2)

(d) Annual (250/1)

(b) VAR6 years = Z Score × SD6 years

VARtrader = VARFirm × Share Allotted × Beta

VAR5 = VAR1 × √t = SD1 × Z Score × √5

VAR250 days = VAR1 day × ඥ250

VAREUR = SDEUR × Z Score

VAR2P = VAR2CAD +VAR2EUR +2VARCAD VAREUR rCADEUR

σ2P = σ2CAD +σ2EUR +2σCAD σEUR rCADEUR

(c) Marginal VAR = New VARP -Old VARP

New VAR2P = VAR2CAD +VAR2EUR +0

You are required to determine the maximum possible investment.

Thus the Value of 1.875 shall be = 0.4693 + 0.0003 = 0.4696

Date 1 2 3 = 1-2 4 = 3 × 0.062 5 = EMA (2 + 4)

11 31000 29983.32 1016.68 63.034 30046.354

EMA is calculated (30 days in this question)

Date Closing Sensex Sign of Price Charge

Total of price changes (r) = 8

2n1 n2 (2n1 n2 -n1 -n2 )

Test at 5% level of significance at 18 degrees of freedom using the t-table.

At 10% level of significance at 18 degrees of freedom

7 33340.89 33340.89 33310.95 33330.98

You are required:

-12.48 14.61 155.75 213.45 -182.33

∑ X =-194.96 ∑ Y =68.08 ∑ X2 =6848.66 ∑ Y2 =6745.74 ∑ XY =164.68

Ve = Market value of the share

Hence, if Walter model is applied-

(ii) Cost of capital i.e. (Ke) 12%

Here D = 8.40x; E = ₹8.40; r = 0.15 and Ke = 0.12 and P = ₹56

E = Earnings per share

(i) Value of the Company if payout ratio is 15%

(ii) Value of the Company if payout ratio is 30%

(iii) Value of the Company if payout ratio is 60%

(iv) Value of the Company if payout ratio is 90%

Value of Summit Ltd. = ₹15,857.99 × 15,00,000 = ₹2,378.70 Crores

36.25k2e = 1.80ke +0.64

Alternatively, it can also be calculated as follows:

ke2 – 0.16 ke + 0.11 ke – 0.0176 = 0

Thus limiting value is ₹31.25

Thus limiting value is ₹39.06

Market Value of the Share

P0 = PV of Constant Dividend for first 5 years + PV of Share after 5 years

(ii) Walter’s Formula

(i) Calculate the present value of the stock.

Since, Actual Stock Price is higher, hence it is overvalued.

Since, Actual Stock Price is lower, hence it is undervalued.

Year 3 (D3) ₹28.00 (1.09)3 = ₹36.26

Required rate of return = 13% (ke)

P0 = 30.52(0.885) + 33.27(0.783) +36.26(0.693) +720(0.693)