AC 414: TUTORIAL QUESTIONS

1. Distinguish investment and speculation.

2. Explain why you would expect the saving-borrowing pattern to differ by occupation
(for example, for teacher versus a builder).
3. Differentiate between real assets and financial assets with examples.
4. Securities are traded on the market. Explain briefly the following financial markets:
(a) Call market
(b) Auction market
(c) Over-the-counter market
(d) Money market
(e) Continuous market
5. Differentiate between systematic and unsystematic risk
6. What are the differences between technical and fundamental analysis?

7. Explain why the issues of selectivity, timing and diversification are important when
forming the investment portfolio.

8. What does covariance measure? If two assets are said to have positive covariance,
what does it mean?

9. How do you understand an investment risk and what statistic tools can be used to
measure it?

10. For each of the following probability distributions, calculate

(i) Expected return for stock and bond
(ii) Variance and Standard deviation of stock and bond
(iii) Covariance between stock and bond
(iv) Correlation coefficient between stock and bond
(v) Coefficient of determination

State Probability Stock Return Bond Return

Good 0.30 $60 $25
Normal 0.50 $30 $30
Bad 0.20 $20 $82

11. Using the efficient market hypothesis, differentiate between a weak form efficiency,
semi-strong form, and strong form efficiency.

12. Explain why most investors prefer to hold a diversified portfolio of securities as
opposed to placing all of their wealth in a single asset.

13. Dubes currently owns shares in KimShel Mutual Fund (KMF). He has received a call
from his broker who recommends buying shares in a small capitalization fund
managed by One Connect Investment Group (OCIG). The broker says that this fund
will provide significant diversification benefits for Dubes’ existing holdings. The
 broker gives Samaita the following statistics based on the performance of the two
funds over the last year.
Portfolio Expected Return Standard Deviation
KMF 15% 10%
OCIG 9% 7%

14. Required:
i. Assume the risk-free rate of return is 6%, which of these funds would be optimal to
combine with the risk free security? Why?
ii. Using the fund you selected in part (i) above, how much portfolio weights in the
fund and the risk-free security would be required to earn a target return of 22%?
Describe this position.

iii. Assume the co-variance between KMF and OCIG funds is 0.2, what would have
been Samaita’s return and standard deviation over the last year if he had placed 45%
of his investment in KMF and the remainder of his investment in OCIG?

15. The following investment portfolios are evaluated by investor:

Portfolio Expected rate of return % Standard deviation

A 12 15
B 10 8
C 10 9

Using portfolio theory explain the choice for investor between Portfolios A, B and C.

16. Investor owns the portfolio composed of three stocks. The Betas of these stocks and
their proportions in portfolio are shown in the table. What is the Beta of the investor’s
portfolio?
Stock Beta Proportion in portfolio %
A 0.8 30
B 1.2 40
C -0.9 30

17. If the investor wants to reduce risk in his portfolio how he could restructure his
portfolio?

13. The new little known firm is analyzed from the prospect of investments in its shares by
two friends. The firm paid dividends last year 3 EURO per share. Tomas and Arnas examined
the prices of similar stocks in the market and found that they provide 12 % expected return.
The forecast of Tomas is as follows: 4 % of growth in dividends indefinitely. The forecast of
Arnas is as follows: 10% of growth in dividends for the next two years, after which the
growth rate is expected to decline to 3 % for the indefinite period.
a)What is the intrinsic value of the stock of the firm according to Tomas forecast?
b)What is the intrinsic value of the stock of the firm according to Arnas forecast?
c)If the stocks of this firm currently are selling in the market for 40 EURO per share, what
would be the decisions of Tomas and Arnas, based on their forecasting: is this stock attractive
investment? Explain.

14. Bond with face value of 1000 EURO, 2 years’ time to maturity and 10 % coupon rate,
makes semi-annual coupon payments and provides 8% yield to maturity.
a) Calculate the price of the bond.
b) If the yield-to-maturity would increase to 9%, what will be the price of the bond? How this
change in the yield-to-maturity would influence bond price?

15. Distinguish the two strategies/approaches to management of portfolio:

i. Passive portfolio management and;
ii. Active portfolio management.

16. Why benchmark portfolios are important in investment portfolio management?

17. Briefly describe each of the portfolio performance measures and explain how they are
used:
a) Sharpe’s ratio;
b) Treynor’s ratio;
c) Jensen’s Alpha.

18. In stock analysis, explain what is meant by top-down forecasting approach and bottom-up
forecasting approach.

19. What is the duration in years of a 4 year 8% bond with a par value of $1 000 and a YTM
of 10%?

20. Explain in brief what is meant by each of the following examples of derivatives:
i. Forwards
ii. Interest rate swaps
iii. Futures
iv. Options

21. (i) Describe what the Capital Asset Pricing Model (CAPM) is intended to explain.

(ii) What assumptions does the CAPM make? Which of these assumptions are not made by
the Markovitz model of portfolio choice? What is the consequence of the additional
assumptions?
(iii) What is the security market line? If the CAPM is true, will all securities have observed
returns that are on the security market line? Explain your answer. [10 marks]
(iv) How can you use CAPM to value a new issue of stock?

22. Comment the differences between investment in financial and physical assets using
following characteristics:
a) Divisibility
b) Liquidity
c) Holding period
d) Information ability
23. Why Treasury bills considered being a risk free investment?

24. Explain the differences between

a) Money market and capital market;
b) Primary market and secondary market.

25. Explain why the issues of selectivity, timing and diversification are important when
forming the investment portfolio.

26. What factors might an individual investor take into account in determining his/her
investment policy?

27. Distinguish between historical returns and expected returns.

28. What does covariance measure? If two assets are said to have positive covariance, what
does it mean?

29. How do you understand an investment risk and what statistic tools can be used to measure
it?

30. What is the interpretation of the coefficient of determination for the investor? If the
coefficient of correlation for two securities is 0,7, what is the coefficient of determination?

31. Describe the Beta factor.

32. What does the characteristic line tells to investor? Why stock characteristic lines are
different for the securities traded in the same market?

33. Refer to the following information on joint stock returns for stock 1, 2, and 3 in the table
Probability return return return
Stock 1 Stock 2 Stock 3
0.20 0.20 0.25 0.10
0.30 -0.05 0.10 0.05
0.25 0.10 0.05 0
0.25 0 -0.10 -0.05

Required
If you must choose only two stocks to your investment portfolio, what would be your choice?
a) stocks 1 and 2; b) stocks 1 and 3; c) stocks 2 and 3; d) other decision.

34. Present your arguments and calculations, to explain your decision.

Month Rate of return Rate of return
Stock A Market Portfolio
1 0.30 0.12
2 0.24 0.08
3 -0.04 -0.10
 4 0.10 -0.02
5 0.06 0.08
6 0.10 0.07

a) Calculate the main statistic measures to explain the relationship between stock A and the
market portfolio:
• The sample covariance between rate of return for the stock A and the market;
• The sample Beta factor of stock A;
• The sample correlation coefficient between the rates of return of the stock A and the
market;
• The sample coefficient of determination associated with the stock A and the market.
b) Draw in the characteristic line of the stock A and give the interpretation – what does it
show for the investor?

35. Explain why most investors prefer to hold a diversified portfolio of securities as opposed
to placing all of their wealth in a single asset.

36. In terms of the Markowitz portfolio model, explain, how an investor identify his /her
optimal portfolio. What specific information does an investor need to identify optimal
portfolio?

37. Comment on the risk of the stocks presented below. Which of them are more /less risky
and why?
Stock Beta
A 0.92
B 2.20
C 0.97
D -1.12
E 1.18
G 0.51

38. What is meant by an efficient market? What are the benefits to the economy from an
efficient market?

39. If the efficient market hypothesis is true, what are the implications for the investors?
If stock’s prices are assumed to reflect any information that may be contained in the past
history of the stock price itself, this is
a) Strong form of efficiency;
b) Semi-strong form of efficiency;
c) Weak form of efficiency;
d) Not enough information to determine form of efficiency.
40. The following table presents the three-stock portfolio.
Stock Portfolio weight Coefficient Beta Expected return Standard
deviation
A 0.25 0.50 0.40 0.07
B 0.25 0.50 0.25 0.05
 C 0.50 1.0 0.21 0.07

Variance of the market returns is 0,06.

a) What is the Beta coefficient of the portfolio?
b) What is the expected rate of return on the portfolio?
c) What is an actual variance of the portfolio, if the following actual covariance between the
stock’s returns is given:
Cov (rA, rB) = 0,020
Cov (rA, rC) = 0,035
Cov (rB, rC) = 0,035

41. Common stock hasn‘t term to maturity. How then can a stock that does not pay dividends
have any value? Give an examples of such firms listed in the domestic market of your
country.

42. What is the difference between blue chip and income stocks?

43. Give examples of defensive stocks in the domestic market of your country.

44. Present the examples of blue chip stocks in the domestic market Explain, why did you
categorize them as blue chips.

45. What is the purpose of bond ratings? If the bonds ratings are so important to the investors
why don‘t common stock investors focus on quality ratings of the companies in making their
investment decisions?

46. How would you expect interest rates to respond to the following economic events (what
would be the direction of the interest rates changes)? Explain why.
a) Increase in investments;
b) Increase in savings level;
c) Decrease in export;
d) Decrease in import;
e) Increase in government spending;
f) Increase in Taxes.

47. What is a key factor in analyzing bonds? Why?

48. Distinguish between yield-to-call and yield-to-maturity.

49. What is the difference between the market expectation theory and the liquidity preference
theory?

50. Distinguish between a put and a call.

51. What does it mean to say „an option buyer has a right but not an obligation?

52. Explain the following terms used with the options:

a) „In the money“
b) „Out of money“
c) „At the money“
53. Assume you hold a well-diversified portfolio of common stocks. Under what conditions
might you want to hedge it using a stock index option?
a) Explain how these options can be used for hedging.
b) What happens with your hedged portfolio if the stock market will fall?
c) What happens with your hedged portfolio if the stock market will grow?
54. Assume that you plan to construct a portfolio aimed at achieving your stated objectives.
The portfolio can be constructed by allocating your money to the following asset classes:
common stock, bonds, and short-term securities.
a) Identify state and comment your investment objectives.
b) Determine an asset allocation to these three classes of assets considering your stated
investment objectives. Explain your decision.
c) What reasons could cause you to make changes in your asset allocations?
55. Give the arguments for active portfolio management.

56. What are the reasons which cause investors managing their portfolios passively to make
changes their portfolios?

57. What are the major differences between active and passive portfolio management?

58. Explain the role of revision in the process of managing a portfolio.

59. Distinguish strategic and tactical asset allocation.

60. What role does current market information play in managing investment portfolio?

61. Why is the asset allocation decision the most important decision made by investors?

62. What is the point of investment portfolio rebalancing?

63. What changes in investor’s circumstances cause the rebalancing of the investment
portfolio? Explain why.

64. Why is portfolio revision not free of cost?

65. Why benchmark portfolios are important in investment portfolio management?