Chapter 20: Portfolio Evaluation

Q. 7. Santosh wants to decide between two mutual funds X and Y. From the financial
reports, he is able to calculate the average returns and the standard deviations for
the funds. The current risk free rate of interest is 7 per cent. Using the Sharpe
index compare the performance of X and Y funds.

X Y

Average return R 19% 17%

Standard Deviation 21 16

Solution:
Rp − R f
Sharpe Index =
σp

19 − 7
Fund X = = 0.57
21
17 − 7
Fund Y = = 0.625
16
According to Sharpe Index Fund Y’s performance is better.
Q. 8. With a 9 per cent risk free rate of return, the NSE- Nifty portfolio is having an
expected return of 21 per cent and a standard deviation of 8. In the ‘X’ portfolio,
the mean is 15 per cent and standard deviation is 8. In the ‘Y’ portfolio, the mean
is 20 per cent and the standard deviation is 12. For portfolio ‘Z’, the return is
21 per cent and standard deviation is 16. Choose the best portfolio.
Solution:
21 − 9
NSE Nifty Portfolio = = 1.5
8
15 − 9
X portfolio = = 0.75
8
20 − 9
Y portfolio = = 0.91
12
21 − 9
Z portfolio = = 0.75
16
The best portfolio is NSE Nifty portfolio.

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Q. 9. Following table provides the details about 3 portfolios. Find out the difference
between the actual and expected return using Jensen index. On the basis of your
calculation rank them.

Portfolio Return on Portfolio Portfolio Beta Risk Free Interest

Rate
1 15 1.3 6%
2 12 0.9 6%
3 18 1.6 6%
Market Index 11 1.0 6%

Solution:
Jenson’s Model: Rp = α + β (Rm – Rf)
Portfolio 1: Rp1 = 6 +1.3 (11 – 6)
Rp1 = 6 + 6.5
Rp1 = 12.5
Portfolio 2: Rp2 = 6 + 0.9 (11 – 6)
Rp2 = 6 + 4.5
Rp2 = 10.5
Portfolio 3: Rp3 = 6 + 1.6 (11 – 6)
Rp3 = 14
Fund No. Actual Return Estimated Difference Rank
Return

1 15 12.5 2.5 I
2 12 10.5 1.5 II
3 18 14.0 – 4.0 III

Q. 10. With the given details, evaluate the performances of the different funds using
Sharpe, Treynor and Jensen performance evaluation techniques.

Funds Return Standard Deviation Beta

A 12 20 0.98
B 12 18 0.97
C 8 22 1.17
D 9 24 1.22

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 Risk free rate of return is 4 per cent. Market return is 10 %.
Rp − R f
Solution: Sharpe =
σp
2−4
Fund A: = = – 0.1 …(4)
20
12 − 4
Fund B: = = 0.44 …(1)
18
8−4
Fund C: = = 0 .18 …(3)
22
4−4
Fund D: = = 0.21 …(2)
24
Rp − R f
Treyner =
Bp
2−4
Fund A: = = – 2.04 …(4)
0.98
12 − 4
Fund B: = = 8.25 …(1)
.97
8−4
Fund C: = = 3.42 …(3)
1.17
9−4
Fund D: = = 4.1 …(2)
1.22
Jensen:
Rp = α + Rf + B(Rm – Rf)
Fund A: 2 = α + 4 + .98 (10 – 4)
α = 7.88 …(1)
Fund B: 12 = α + 4 + .97 (10 – 4)
α = 2.18 …(2)
Fund C: 8 = α + 4 + 1.17 (10 – 4)
α = – 3.02 …(4)

Fund D: 9 = α + 4 + 1.22 (10 – 4)

α = – 2.32 …(3)

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Q. 11. The rates of return for three growth oriented mutual funds for the past six years
are given below:

Growth Fund Return Risk (α)

Pearl Fund 16 % 15
Diamond Fund 14 % 17
Ruby Fund 13 % 10
T. Bills 8% —

Rank each fund by Sharpe’s index of portfolio performance.

Solution:
Rp − R f
Sharpe’s Index =
σp

16 − 8
Pearl Fund = = 0.53 …(1)
15
14 − 8
Diamond = = 0.35 …(3)
17
13 − 8
Ruby = = 0.5 …(2)
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Q. 12. Rank the three funds given below with the help of Treynor and Sharpe index.

Growth Fund Return Beta α

X 15 1.5 12
Y 17 1.6 14
Z 13 .75 11
Rf 9 per cent

Is there any difference in the ranking according to these measures? If so why?

Solution:
Rp − R f
Sharpe Index =
σp

15 − 9
X = = 0 .50 …(2)
12

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 17 − 9
Y = = 0 .57 …(1)
14
13 − 9
Z = = 0 .36 …(3)
11
Rp − R f
Treynor’s Model =
βp
15 − 9
X = =4 …(3)
1.5
17 − 9
Y = =5 …(2)
1.6
13 − 9
Z = = 5.33 …(1)
0.75
There is a difference in the ranking pattern because Sharpe index takes the total risk for
estimation and Treynor’s index takes the market risk for estimation.
Q. 13. Sun Rise Company manages two mutual funds. The funds are index Fund and
Equity fund. The data below provide the key statistical information.

Return per cent Risk Beta r

Equity Fund 19 18 1.49 .83
Index Fund 13 16 1.08 .68
Market 14 10 1.0 1.00
Rf 5

(a) According to Jensen method which fund performs well?

(b) In your opinion, which fund consists more of systematic risk?

Solution:
(a) Jensen Model Rp = α + Rf + β (Rm – Rf)
Equity Fund: 19 = α + 5 + 1.49 (14 – 5)
19 = α + 18.41
α = 0 .59
Index Fund: 13 = α + 5 + 1.08 (14 – 5)
13 = α + 14.72
α = – 1.72
(b) Equity fund consists of higher systematic risk with higher beta value.

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Q. 14.The following table gives the data about three funds.
Portfolio Ri (%) Beta Rf (%)
A 14 1.3 6
B 12 0.9 6
C 18 1.6 6
Market Index 3 1.0 6

Compare the funds’ performance.

Solution:
A 14 = α + 6 + 1.3 (13 – 6)
α = – 0 .1
B 12 = α + 6 + 0.9 (13 – 6)
α = – 0.3
18 = α + 6 + 1.6 (13 – 6)
α = 0.8
The fund C alone has A positive α value. Fund ‘C’ should be selected.

Q.15. The Equity fund, T. Bills and BSE Sensex are assumed to have had the following
returns over the past 5 years.

Period Equity Fund Return Sensex Return T. Bill Return

per cent per cent per cent
20 × 2 9 7 5
20 × 3 –3 –1 4
20 × 4 15 12 6
20 × 5 14 13 9
20 × 6 18 16 8

(a) Determine the Equity Fund’s α and β coefficients for the 5 year period of time.

(b) If the market return is 20 per cent and the risk free rate of return is 10 per cent,
what will be the α value for the assured return of 25 per cent from the fund?

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Solution:
(a)

(Rp – Rf) (Rm – Rf)

Period Rp Rm Rf Y X X2 XY

19 × 2 9 7 5 4 2 4 8

19 × 2 –3 –1 4 –7 –5 25 35

19 × 4 15 12 6 9 6 36 54

19 × 5 14 13 9 5 4 16 20

19 × 6 18 16 8 10 8 64 80

21 15 145 197

N ΣXY −ΣX ΣY
β =
N ΣX 2 − (ΣX ) 2
5 ×197 − (15 × 21)
β =
5 × 145 − (15)2
985 − 315 670
β = = = 1.34
725 − 225 500
α = Y −β X
= 4.2 – (1.34 × 3)
= 4.2 – 4.02 = + 0.18
(b) Rp = α + Rf + β (Rm – Rf)
25 = α + 10 + (1.34) (20 – 10)
25 = α + 10 + 13.4
25 = α + 23.4
α = 1.6.