KENYATTA UNIVERSITY

UNIVERSITY EXAMINATIONS 2009/2010

SECOND SEMESTER EXAMINATION FOR THE DEGREE OF
BACHELOR OF COMMERCE

BAC 408: APPLIED INVESTMENT

DATE: Wednesday 7th April 2010 TIME: 2.00p.m – 4.00p.m

INSTRUCTIONS
1) Answer all Questions
2) Marks allocated are shown at the end of each question.
3) Show all your workings.

Question One
a) The following are historical returns for the Anita Computers Company Limited.
Year Anita General
Company Limited
1 37 15
2 9 13
3 -11 14
4 8 -9
5 11 12
6 4 9

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Required:
i) Compute the correlation coefficient between Anital Computer Company Limited
and the General index. [8marks]
ii) Compute the Beta for the Anital Computer Company limited. [2marks]
b) The portfolio identified below are been considered for investment. During the
period under consideration, the risk free rate was 14%.
The following information is also provided.
Portfolio Return Beta P (%)
A 30% 2.0 10%
Q 40% 3.0 20%
R 20% 1.2 60%
S 34% 2.2 12.0%
Market 26% 1.0 8.0%
Required:
i) Compute the shape measure of each portfolio and the market portfolio.
[4marks]
ii) Compute the Treynor measure of each portfolio and the market portfolio.
[4marks]
iii) Rank the portfolio using each measure. [2marks]

Question Two

A division of Bewcast p/c has been allocated a fixed capital sum by the main board of
directors for its capital investment during the next year. The division’s management has
identified three capital investment projects, each potentially successful, each of similar
size, but has only been allocated enough funds to undertake two projects. Projects are not
divisible and cannot be postphoned until a later date.

The division’s management proposes to use portfolio theory to determine which two
projects should be undertaken, based upon an analysis of the projects’ risk and return.

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The success of the projects will depend upon the growth rate of the economy. Estimates
of project returns at different levels of economic growth are shown below.
Economic growth Probability of Estimated Return (%)
(Annual Average) Occurrence Project 1 Project 2 Project 3
Zero 0.2 2 5 6
2 per cent 0.3 8 9 10
4 percent 0.3 16 12 11
6 percent 0.2 0.2 25 11
You are required
a) to use the above information to evaluate and discuss which two projects the
division is likely to undertake. All relevant calculations must be shown.
[14marks]
b) to state the weaknesses of the evaluation techniques used in (a) above. What
further information might be useful in the evaluation of these projects?
[4marks]
c) to suggest why portfolio theory is not widely used in practice as a capital
investment evaluation technique. [3marks]
d) to recommend and briefly describe, and alternative investment evaluation
techniques that might be applied by the division . [4marks]
[Total: 25marks]
Question Three
a) Formulate and justify and investment policy statement setting for the appropriate
guidelines within which future investment actions should take place. Your policy
statement must encompass all relevant objective and constraint considerations.
[9marks]
b) Briefly describe three active bond portfolio management strategies.
[6marks]
[Total: 15marks]

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Question Four
a) The Arbitrage Pricing Theory (APT) and Capital Asset Pricing Model (CAPM)
have received much attention form practioners and academicians for use in assets
pricing and valuation.
Required:
Explain the conceptual difference between the Arbitrage Pricing Theory (APT)
and Capital Asset Pricing Model (CAPM). [5marks]
b) An investor is evaluating six portfolio with the following characteristics.
Portfolio Portfolio Expected Returns Portfolio Standard
Deflation %
1 19 8
2 25 12
3 16 6
4 32 16
5 22.5 10
6 8 2
The expected return on the market portfolio is 12% with an accompanying standard
deviation of 4%. The risk free rate of interest is 5%.
Required:
i) Using the Capital Market line, advise the investor on which of the above portfolio
are efficient and inefficient. [7marks]
ii) In the case of an inefficient portfolio in (i) above state what the standard deviation
should be for efficiency to be achieved with the given expected returns. [3marks]
[Total: 15marks]

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 KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2010/2011
SECOND SEMESTER EXAMINATION FOR THE DEGREE OF BACHELOR
OF COMMERCE
BAC 408: APPLIED INVESTMENT

DATE: Friday 8th April, 2011 TIME: 8.00 a.m. – 10.00 a.m.
___________________________________________________________________________________
INSTRUCTIONS
Answer ALL questions.
Question one
„Many emerging equity markets provide large expected returns but are also associated with significant risks.‟
a. Briefly discuss four major risks that an investor participating in such markets is exposed to.
[4 marks]
b. Maendeleo Ltd has issued bonds that pay semiannual coupons with the following characteristics:
Coupon rate: 8%
Yield to maturity: 6%
Maturity: 5 years
Par value: shs.1000
Current price: shs.1085.3
Required:
Using the above data for Maendeleo Ltd calculate the bonds:
i. Macaulay duration [4 marks]
ii. Modified duration [2 marks]
iii. Convexity [2 marks]
iv. The approximate price change for this bond if its yield to maturity declined by 300 basis points.
(Consider both the duration and convexity effects) [3 marks]
v. What would happen to your price change if this was a callable bond? [2 marks]

The government recently amended the law in Kenya to allow sharing of credit information among banks through
credit reference bureaus.

Required:
c. Highlight the benefits of this amended law to a borrower. [3 marks]
[Total 20 marks]

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Question two
One of the most important tools in evaluation the performance of securities is the Capital Asset Pricing Model
(CAPM). In recent years this tool has come under intense criticism and the Arbitrage Pricing Model (APT) has
been suggested as an alternative pricing model.
Required:
a. What difficulties do you see in using APT to develop an active management strategy?
[6 marks]
b. Based on five years of monthly data, you derive the following information for the companies listed
below:
Company Standard deviation Correlation with market proxy
Alpha 12.10% 0.72
Delta 14.60% 0.33
Blue 7.60% 0.55
Gold 10.20% 0.60
Market proxy 5.50% 1.00

Assume a risk free rate of 8% and an expected return for the market portfolio of 15%.
Required:
i. Compute the beta coefficient for each stock. [4 marks]
ii. The following returns have been estimated for the next year:
Alpha 20%
Delta 15%
Blue 19%
Gold 10%
Compute the alphas for all the stocks and select the best. Justify your selection. [5 marks]
iii. Calculate the portfolio beta for the securities you have selected in (iii) above assuming it is equally
weighted. [2 marks]

iv. Identify and briefly discuss three criticisms of beta as used in CAPM. [3 marks]
[Total 20 marks]
Question three
a. You are the finance manager of Safe Ltd. on 28 August Safe‟s board of directors decides that in 7 weeks‟
time Safe will issue nine bank bills each with a face value of shs.1 million and a term of 120 days. In its
planning the board had assumed that yields will not change from their current levels of 14.07 per cent per
annum. On 29 August you arrange for a hedge by selling nine bank bills at a price of Shs.86.1. The bills
were eventually issued after 7 weeks at a rate of 15.37 per cent per annum and the futures contract was
reversed at shs.84.65.

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Required
i. The gross dollar shortfall that Safe Ltd would have faced if a futures contract had not been entered into.
[3 marks]
ii. The gain made on the futures contract. [2 marks]
iii. A brief assessment of the effectiveness of the hedge. [3 marks]
iv. Highlight two advantages of hedging using financial futures as compared to forwards.
[2 marks]
b. A call option has the following data:
Exercise price: shs.6
Term to maturity: 2 months
Current share price: Shs.6.5
“up” factor: 1.05 per month
“down” factor: 1/1.05 per month
Risk free rate: 1 percent per month
i. Using the binomial model determine the value of the call above. Use two time periods
each of 1 month. [8 marks]
ii. Highlight two advantages of hedging using options as compared to forwards.
[2 marks]
[Total 20 marks]

Question Four
List and briefly discuss five differences in investment policy that might result from the following two investors:
i. The pension plan of a young, and success entrepreneur aged 28 years.
ii. The modest life insurance proceeds received by a 60 year old widow with two grown children.
[10 marks]
………………..

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 KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2010/2011
FIRST SEMESTER EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE

BAC 408: APPLIED INVESTMENTS

DATE: Thursday 2nd December 2010 TIME: 2.00p.m - 4.00p.m

INSTRUCTIONS: Attempt all questions

1. a) Discuss the various types of mutual funds. [15marks]
b) What are the roles of mutual funds in the economy? [10marks]
[Total 25 marks]
2. a) Describe the portfolio management process? [8marks]
b) Mwananchi ltd has been trading at Nairobi Stock Exchange for the last 10
years. The return of its share for the last six years and the market returns
are shown below:
Year Return (%)
Mwananchi ltd Market returns
1 18 15
2 9 7
3 20 16
4 -10 -13
5 5 4
6 12 7

Required:
i) Calculate the covariance and correlation coefficient of returns. [8marks]
ii) Determine the beta coefficient for the Mwananchi share. [5marks]
iii) Distinguish between systematic and unsystematic risk. [4marks]
[Total 25 marks]

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3. a) To what extent is the Nairobi Stock Exchange an emerging capital Market.
[10marks]
b) Distinguish between technical asset allocation and fundamental asset
allocation. [6marks]

c) Differentiate the Dow Theory and Hatch system using relevant examples.
[9marks]
[Total 25 marks]

4. a) The following portfolios are being considered for investment. During the
period under consideration, the risk free rate is 7%.

Portfolio Return Beta Standard deviation

A 0.15 1.0 0.05
B 0.20 1.5 0.10
C 0.10 0.6 0.03
D 0.17 1.1 0.06
Market 0.13 1.0 0.04

Required:
i) Compute the Sharpe measure for each portfolio and the market portfolio.
[6marks]
ii) Compute the Treynor measure for each portfolio and market portfolio.
[6marks]
iii) Rank the portfolios using each measure and explain the cause for any differences
in the ranking. [8marks]

b) Briefly discuss the Hamanda model in (CAPM) and how it related to the
firm. [5marks]
[Total 25 marks]

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 KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2011/2012
FIRST SEMESTER EXAMINATION FOR THE DEGREE OF BACHELOR OF COMMERCE
BAC 408: APPLIED INVESTMENT

DATE: Thursday 8th DECEMBER 2011 TIME: 8.00 A.M. – 10.00 A.M.

INSTRUCTIONS:
1. Answer all questions
2. Show all your workings
3. Marks allocated are shown at the end of each question

Question One
(a) Two investors, X and Y, have portfolios which lie on the Capital Market Line. X has one
third of his funds invested at a risk free rate, which is 12%, and the remainder in a
market portfolio of equities. The expected return on his total portfolio is 18% with a
standard deviation of 12%. Y’s expected return on his total portfolio is 24%. Both investors
can lend and borrow at the risk free rate.
Required:
i. Explain, with supporting calculations, the composition of the expected return of both
portfolios in terms of equity returns and fixed interest. (6 marks)
ii. Give a freehand graphical representation of the Capital Market Line showing the
position of each investor’s portfolio. (4 marks)
iii. On the assumption that X wishes to keep his portfolio on the Capital Market
line, calculate what standard deviation he would have to accept in order to
increase his expected return to 20% and explain how the composition of his
portfolio would change. (3 marks)
(b) Explain the conceptual difference between the Arbitrage Pricing Theory (APT) and
Capital Assets Pricing Model (CAPM). (7 marks)
(Total 20 marks)

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Question Two
(a) Differentiate between passive and active bond management strategies. (3 marks)
(b) Explain any four active bond management strategies. (12 marks)
(Total: 15 Marks)

Question Three
(a) Describe the portfolio management process. (5 marks)
(b) An analyst want to evaluate Portfolio X, consisting entirely of US common stocks,
using both the Treynor and Sharpe measures of portfolio performance. The table
below provides the average annual rate of return of Portfolio X, the market portfolio
(as measured by the Standard and Poor’s 500 index), and US Treasury bill (T-bills)
during the past 8 years.

Annual Average Standard Deviation Beta

rate of return of return
Portfolio X 10% 18% 0.60
S & P 500 12 13 1.00
T-bills 6 n/a n/a

(i) Calculate both the Treynor measure and Sharpe measure for both the Portfolio
X and the S & P 500. Briefly explain whether portfolio X underperformed,
equaled or outperformed the S & P 500 on a risk-adjusted basis using both the
Treynor measure and the Sharpe measure. (5 marks)
(ii) Based on the performance of Portfolio X relative to the S & P 500 calculated
in part (a), briefly explain the reason for the conflicting results when using the
Treynor measure verses the Sharpe measure. (5 marks)
(c) Rank the portfolio using each measure, explaining the cause for any differences you
find in the rankings. (5 marks)

(Total: 20 marks)

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Question Four
(a) For an investment portfolio consisting of a large number of securities, the important
feature determining the riskiness of a portfolio is the way in which the returns on the
individual securities vary together.
Illustrate this statement by making calculation from the simplified data given in the table
below in relation to a portfolio comprising 40% of Security A and 60% of Security B.
You may ignore the possibility of no correlation between the rates of return.

Predicted return Predicted return

Probability
Security A (%) Security B (%)
0.2 12 15
0.6 15 20
0.2 18 25
(7 marks)
(b) An investor in risky securities is presumed to select an investment portfolio which on
the efficient frontier and touches one of his indifference curves at a tangent.
Required:
(i) Give a detailed explanation of the above statement, with particular attention
to the expression in italics.
(ii) Illustrate your answers with relevant diagram. (8 marks)
(Total: 15 Marks)

***************************

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 KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2008/2009
INSTITUTE OF OPEN LEARNING (IOL)
EXAMINATION FOR THE DEGREE OF BACHELOR OF COMMERCE

BAC 408: APPLIED INVESTMENT

DATE: Monday, 15th February, 2010 TIME: 11.00 a.m. – 1.00 p.m.
------------------------------------------------------------------------------------------------------------
INSTRUCTIONS:
Answer ALL questions.
Question 1
The following data is offered on two stocks:
Stock Expected Return Standard Deviation
X 0.15 0.30
Y 0.10 0.20
______________________________________________________________________
The correlation between the two stocks is + 1.0
Determine the expected return and risk on the following combinations if these stock:
% stock X % stock Y
a 70 30
b 50 50
c 30 70
d 10 90
(20 marks)

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Question 2
a) Distinguish between a feasibility and an efficient portfolio; and explain whether it
is possible to have a portfolio which is both efficient and feasible. (5 marks)
b) The standard deviation of return of security Y is 20 per cent and of market
portfolio is 15 per cent. Calculate beta of Y if
i) Corym = 0.70 (5 marks)
ii) Corym = + 0.40 (5 marks)
iii) Corym = - 0.25 (5 marks)

Question 3
a) Explain the assumptions and principles underlying the portfolio theory.
(5 marks)
b) An investor holds two equity shares X and Y in equal proportions with the
following risks and return characteristics:
E (Rx) = 24% E (Ry) = 19%
 x  28%  y  23%
The returns of these securities have a positive correlation of 0.6.
Required:
i) Calculate the portfolio return and risk (5 marks)
ii) Suppose that the investor wants to reduce the portfolio risk (  p  to 15%,

how much should the correlation coefficient be to bring the portfolio risk
to the desired level? (5 marks)

Question 4
Diamond Limited stock had the following rates of return for 2001 – 05; 0.20, 0.13, -0.09,
0.05, -0.11.
i) What is the arithmetic average rate of return on Diamond’s stock over this period?
(6 marks)
ii) What is the Geometric average of the stock? (6 marks)
iii) Explain why the two returns are different. (3 marks)

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 KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2009/2010
OPEN, DISTANCE AND E-LEARNING EXAMINATION FOR DEGREE OF
BACHELOR OF COMMERCE
BAC 408: APPLIED INVESTMENT
DATE: Friday 23rd July , 2010 TIME: 11.00 a.m – 1.00 p.m
------------------------------------------------------------------------------------------------------------
INSTRUCTIONS:
Answer ALL Questions
Question 1
a) A 10 year bond of Kshs 1000 has an annual rate of interest of 12 per cent. The
interest is paid half yearly. If the required rate of return is 16 per cent, what is the
value of the bond? [10 marks]
b) Risk components are divided into systematic and non-systematic, explain these
elements of risk.
Question 2
Consider the following data for the year 2007.
Portfolio: Market:
Average return 54% 38%
Beta 1.40% 1.00%
Standard deviation 52% 40%
Non-systematic risk 28% 0%
Required:
a) Calculate the following performance measures for portfolio P and the market:
i) Sharpe [ 2 marks]
ii) Jensen [ 2 marks]
iii) Trey nor [ 2 marks]
iv) Appraisal [ 2 marks]
The T- Bill rate during the period was 9%

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b) By which measure did the portfolio outperform the market? [2 marks]
c) Explain the Random Walk theory. [ 5 marks]

Question 3
a) Securities of Manker Ltd( (M) and those of Channia transporters (c) are equally
risky, but they have different expected returns as follows;
Manker ( M ) Channia ( C)
E(R) = 0.16 E(R) = 0.24
W Manker = 0.50 W Channia = 0.05
 2 Manker = 0.40  2 Channia = 0.04
 Manker = 0.20  Manker = 0.20

Required:
Calculate the portfolio variance when
i) Cor mc = + 1.0 [ 5 marks]

ii) Cor mc = -1.0 [ 5 marks]

iii) Cor mc = + 0.10 [ 5 marks]

iv) Cor mc = - 0.10 [ 5 marks]

Question 4
a) Explain how the Industry life-cycle helps in industry analysis. [ 7 marks]
b) Illustrate how a bullish trend in the market can be identified using Dow theory.
[ 8 marks]

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 KENYATTA UNIVERSITY
UNIVERSITY EXAMINATIONS 2010/2011
INSTITUTE OF OPEN, DISTANCE AND E-LEARNING
SECOND SEMESTER EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
BAC 408: APPLIED INVESTMENTS

DATE: Friday 8th July, 2011 TIME: 2.00 p.m. – 4.00 p.m.
_______________________________________________________________________________
INSTRUCTIONS
1. Answer ALL questions.
2. Show your workings.

Question One
(a) An investor is evaluating six portfolio with the following characteristics:

Portfolio Portfolio Portfolio

Expected Return (%) Standard deviation (%)
1 19 8
2 25 12
3 16 6
4 32 16
5 22.5 10
6 8 2

The expected return on the market portfolio is 12% with an accompanying standard deviation of
4%. The risk free rate of interest is 5%.
REQUIRED:
(i) Using the Capital Market line, advise the investor on which of the above portfolios are
efficient and inefficient. [7 marks]

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 (ii) In the case of an inefficient portfolio in (i) above state what the standard deviation should
be for efficiency to be achieved with the given expected return. [3 marks]
(b) Explain the conceptual difference between the Arbitrage Pricing Theory (APT) and Capital Asset
Pricing Model (CAPM). [10 marks]
[Total 20 marks]
Question two
(a) Larch Ltd is a private family owned company which earns an expected return of 12% on its
existing operations, subject to a standard deviation of 20%. The family holds no other
investments. It is considering a new project which has an expected return of 16%, a standard
deviation of 32% and a correlation of 0.25 with Larch’s existing operations.

The new project would account for 25% of Larch’s operations if accepted. Larch uses a measure
of utility to appraise risky projects. The measure use is:
U = 100r – σ2
Where U = Utility
γ= percentage expected return
σ = percentage standard deviation of return
projects are acceptable if they increase total utility.
Is the new project acceptable? [12 marks]
(b) Compute the return and risk of portfolios of investments A and B when the proportions of the
total amount invested are as follows:

Investment A B
(a) Proportion 0.2 0.8
(b) Proportion 0.7 0.3
[8 marks]
[Total 20 marks]
Question Three
(a) Differentiate between:
(i) Investor
(ii) Speculator [4 marks]
(b) Explain the following terms:

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 (i) Open-end investment company
(ii) Close-end investment company [4 marks]
(c) Using a well labeled diagram, explain Jensen’s measure of portfolio performance.
[7 marks]
[Total 15 marks]
Question Four
a) Describe the portfolio management process. [5 marks]
b) The portfolios identified below are being considered for investment. During the period under
consideration, Risk free rate is 70%
Portfolio Return (%) Beta σi %
P 15 1.0 0.05
Q 20 1.5 0.10
R 10 0.6 0.03
S 17 1.1 0.06
Market 13 1.0 0.04
a) Compute the sharpe measure for each portfolio and the market portfolio.
b) Compute the Treynor measure for each portfolio and the market portfolio.
c) Rank the portfolio using each measure, explaining the cause for any differences you find
in the rankings. [10 marks]
[Total 15 marks]
……………………..

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