ANSWER SHEET OF MINI PROJECT

ANSWER OF QUESTION NO 1:

The T-Bill’s is independent of the state of economy because this is a government issued
security which is free of default and liquidity risk. The government will have to pay the promised
rate of return, regardless of economic conditions.

T-Bill’s do not promise a completely risk free of return since it is still exposed to inflation
risk. It is important to note down that T-Bill’s represent the risk-free rate of return, also it is
different to the real / realized rate of return.

ANSWER OF QUESTION NO 2:

The Nescom returns are expected to move with the economy, investors perceive that
Nescom perform at the same trend as the overall performance of the economy. It it is poor then
the expectation is that Nescom will also perform poorly.

While on the other hand, Nawab returns are expected to move opposite to the economy, so
it shows that investors will perceive that Nawab will perform against the trend of the
performance of overall economy.

ANSWER OF QUESTION NO 3:

Expected rate of return can be calculated by given formula:

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Expected rate of T-Bills:

Expected rate of T-Bills = 3%

Expected rate of return for Nescom:

= 0.1*-14.25% + 0.2*-4.75% + 0.4*6.25% + 0.2*13.75% + 0.1*21.25%

= 0.05 or 5%.

Expected rate of return for Nawab:

= 0.1*12.25% + 0.2*5.25% + 0.4*-0.5% + 0.2*-2.5% + 0.1*-10%

= 0.57 or 57.5%

Expected rate of return for PK-Steel:

= 0.1*1.75% + 0.2*-8.25% + 0.4*0.25% + 0.2*19.25% + 0.1*11.75%

= 3.65 %

Expected rate of return for Market Portfolio:

= 0.1*-9.75% + 0.2*-2.75% + 0.4*3.75% + 0.2*11.25% + 0.1*17.75%

= 4 % Answer.

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ANSWER OF QUESTION NO 4 :

Standard deviation can be calculated by given formula:

Standard deviation of Nescom = (0.00984125) = 9.9%

Standard deviation of Nawab = 5.62%

Standard deviation of Pk-Steel = 9.41%

ANSWER OF QUESTION NO 5

The standard deviation is a measure of a security’s (or a portfolio’s) stand-alone risk. The
larger the standard deviation, the higher the probability that actual realized returns will far below
the expected return, and that losses rather than profits will be incurred.

ANSWER OF QUESTION NO 6

Coefficient of Variation (CV) can be calculated by given formula:

Coefficient of Variation (CV) = Standard deviation / Return

The Coefficient of variation shows the risk per unit of return.

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Coefficient of variation for Nescom = 9.9% / 5% = 1.984

Coefficient of variation for Nawab = 5.62% / 0.57% = 9.766

Coefficient of variation for Pk-Steel = 9.41% / 3.65% = 2.577

Hence above results shows that Coefficient of Variation (CV) of Nascom is the lowest (i.e
1.984) therefore the stock requires investors to take less risk per unit return.

ANSWER OF QUESTION NO 7

Stock Probability Returns Beta (r-r^) (r-r^) p

NASCOM 50% 5% 1.5 2% 0.02% 1.41%

NAWAB 50% 1% -0.6 -2% 0.02% 1.41%

Portfolio
Beta 0.45
Expected
Return 3.00% 0.04%
Expected (Rf + (Rm-Rf)Beta
Return 3.45% 2.00%

Standard Deviation = 0.01%

And Coefficient of variation (CV) = -0.0002000 or 0.02%

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 ANSWER OF QUESTION NO 8

 The investment beta coefficient is a measure of the measure of the sensitivity of a security
of an investment. Portfolio to movements in the overall market. We can derive a statistical
meaning of risk by comparing the returns of an individual security / Portfolio to the returns of the
overall market and identify the proportion of risk that can be attributed to the market. Beta are
use in risk analysis to measure the market risk of individual stocks

 Yes the expected returns appear to be related to each alternative market risk because when
the expected returns fall the coefficient of beta also falls. The given table shows the higher the
expected return the higher will be the risk and beta as well.

 Yes it is possible to choose alternative on the basis of information developed about ratio of
CV. The stock having the lowest CV is appropriate for risk averse investors.

ANSWER OF QUESTION NO 9:

Security Market line equation (SML)

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 Required rate of return for Nescom:

Here Risk-free rate is 3.0%

Beta is 1.5

R = Rf + beta (Rm - Rf)

= R = 3% + beta(4%-3%) = 3% + 1%*beta

= 3% + 1%*1.5 = 4.5%

Required rate of return for Pk-Steel:

= 3% + 1%*0.75 = 3.75%

Required rate of return for Nawab:

= 3% + 1%*-0.6 = 2.4%

Therefore, we can see from above calculation that the undervalued stock is Nescom as its
expected return is higher than the estimated return through SML equation (Security Market line)