BE313-5-AU/1

UNIVERSITY OF ESSEX

SECOND YEAR EXAMINATION 2022

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PORTFOLIO ANALYSIS

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Time allowed: 24 hours

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Maximum word count for assessment: 2000 words

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The paper consists of FOUR questions.

Candidates must answer TWO questions, one from Section A and one from Section B.

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 BE313-5-AU/2

SECTION A
Answer ONE question from SECTION A

QUESTION ONE
a) You are given the following information:

σi ri ρiA ρiB
Security A 15.0% 10.0% 1 0.60
Security B 20.0% 15.0% 0.60 1

Notation:
σ i = Standard deviation of the rate of return on security i = A, B.
ρ ij = Correlation coefficient between the rate of return on assets i and j.
ri = Expected rate of return on asset i.

i. Construct an equally weighted portfolio comprising of these two securities. Calculate the
expected rate of return and the standard deviation of this portfolio (show all the details of
your calculations).
(10 marks)
ii. Now assume that the correlation coefficient is -0.60 (instead of 0.60). Calculate again the
standard deviation of the portfolio.
(5 marks)

iii. Briefly comment on the differences between questions (i) and (ii) (in maximum 150
words). What is the benefit, if any, from the lower correlation coefficient?
(10 marks)

b)

The APT straight line is given by 𝐸𝐸 (𝑅𝑅𝑖𝑖 ) = 𝐸𝐸 (𝑅𝑅𝑧𝑧 ) + [𝐸𝐸 (𝐼𝐼 ) − 𝐸𝐸 (𝑅𝑅𝑧𝑧 )]𝛽𝛽𝑖𝑖 . Suppose there are
three portfolios on this straight line. Given the following information provided, answer the
questions below:

Mean Beta Specific Risk

A 15% 0.7 0
B 21% 1.3 0
C ? 1.8 0

i. What is the slope of the APT line?

(10 marks)
ii. Calculate the 𝐸𝐸 (𝑅𝑅𝑧𝑧 )

(10 marks)
iii. What is the expected rate of return on portfolio C?
(5 marks)

[TOTAL: 50 MARKS]
 BE313-5-AU/3

QUESTION TWO

An investor has constructed a portfolio where 60% of the money are invested in stock 1 and 40% in
stock 2. Given the data below, answer the following:

a) Calculate the betas of stocks 1 and 2.

(10 marks)

b) Calculate the beta of the portfolio.

(5 marks)

c) Calculate the expected return of the portfolio using the CAPM.

(10 marks)

d) According to the CAPM, would you classify stocks 1 and 2 as overvalued or undervalued.
(10 marks)

e) For the risk-free rate, calculate its correlation with the market and its standard deviation.
(5 marks)

f) Briefly discuss the main benefits and drawbacks of the CAPM, compared to other asset-
pricing models (in maximum 150 words).
(10 marks)

Expected return Correlation with the Standard deviation

market portfolio
Stock 1 11.25% 0.90 17%
Stock 2 7% 0.70 12%
Market portfolio 10% 1 13%
Risk free rate 3%

[TOTAL: 50 MARKS]

END OF SECTION A
 BE313-5-AU/4

SECTION B
Answer ONE question from SECTION B

QUESTION THREE

a) Suppose that you are an investor willing to buy a bond. This bond is a 5-year bond, with 6%
coupon rate and a face value of 1,000 pounds. Today, the bond is at par.

i. What is the price of this bond?

(5 marks)

ii. What is the Macaulay duration of this bond?

(10 marks)

iii. If you sell the bond 3 years after, what is your holding period return (assume that the
bond is still at par)?
(10 marks)

b) Assume that you hold a portfolio of 2 bonds. Bond A has a market value (price) of £1000 and
bond B of £2000. The modified duration of bond A is 3.5 and of bond B 1.4.

i. What is the modified duration of your bond portfolio?

(10 marks)

ii. What is the estimated price change (using duration) of your bond portfolio, if yields
increase by 1%?
(5 marks)

iii. How we can improve the approximation of the previous question, especially for large
changes in the yields? Explain your answer in maximum 150 words.
(10 marks)

[TOTAL: 50 MARKS]
 BE313-5-AU/5

QUESTION FOUR

a) The following table provides information about 4 different portfolios. The risk-free rate is 0.01:

Portfolio Portfolio return Standard deviation beta

A 0.14 0.18 1.2
B 0.15 0.15 0.95
C 0.17 0.25 1.4
D 0.22 0.30 2

i. Calculate the Treynor measure and Sharpe ratio for all 3 portfolios (round your results to 3
decimal points)
(10 marks)

ii. Rank the portfolios’ based on those two measures

(5 marks)

iii. Comment on the differences between the rankings (if any). Which measure is more
appropriate if there are indeed differences in the rankings?
(10 marks)

iv. If the market portfolio has a return of 0.14, which fund(s) outperformed the market using the
Treynor measure?
(5 marks)

v. Which measure would you prefer to calculate, if you were only interested in the downside risk
of the portfolio?
(5 marks)

b)
i. Assume that a trader can consistently realize positive abnormal returns on their portfolio by
utilizing publicly available information. Does this violate the weak form of market efficiency
hypothesis? Explain in maximum 150 words.

(10 marks)

ii. Explain in maximum 150 words the upward-sloping yield curve.

(5 marks)

[TOTAL: 50 MARKS]

END OF QUESTION PAPER

PLEASE SEE BE313 WORD DOCUMENT FOR THE ANSWER SHEET