BITS Pilani, Hyderabad Campus Summer Term, 2014

SAPM: Security Analysis and Portfolio Management Ramana Sonti

Assignment 1
Instructions: This problem set contains 3 problems, which you are required to solve. The assignment
submission is due June 23, 2014 in class. Solutions to all problems will be given out June 23.
1. In SimpleLand, there are only two risky stocks A and B, whose details are as follows:
No of shares Price Expected Standard
outstanding per share Return Deviation
Stock A 1000 4 10% 8%
Stock B 500 2 8% 16 %
Further, it is given that the correlation between the two stocks is -0.20. Find the risk-free rate in
this economy, if the CAPM holds in SimpleLand.
2. In ImagineLand, there are only three risky assets X, Y, and Z. The expected (annual) returns for
these three assets are:
=

E(r
X
)
E(r
Y
)
E(r
Z
)

0.4
0.8
0.8

Use the following facts about this economy:

The Capital Asset Pricing Model (CAPM) holds in this economy. i.e. the market portfolio is
MVE.
There are two portfolios W and V known to lie on the mean-variance frontier (of risky assets
only) that have the following weights in X, Y and Z respectively.
W =

0.6
0.2
0.2

and
V =

0.8
0.2
0.4

(a) Find the expected return of portfolios W and V.

(b) Given this information, what are the maximum and minimum values for the expected rate of
return on the market portfolio?
(c) Now suppose you are told that W represents the minimum variance portfolio (MVP) of all
risky assets in this economy. Does this change your answers to part (b) above?
3. The only three risky assets in the economy of CAPMworks are the stocks A, B, and C, which have
expected returns of 30%, 50%, and 60% respectively. The market portfolio comprising the three
assets has an expected return of 55% and a variance of 0.70. Further, it is well known that the
T-bill rate is 20%, and that the CAPM holds. A certain active fund manager, Mr. Sapm Suchs,
has a portfolio of A, B, and C in the proportions 0.3, -0.4, and 1.1 respectively, and claims that
his performance is the same as that of the market portfolio. Is this claim justied?