LOYOLA COLLEGE (AUTONOMOUS), CHENNAI – 600 034 B.A. DEGREE EXAMINATION – ECONOMICS
SIXTH SEMESTER – APRIL 2007
EC 6600 – PORTFOLIO MANAGEMENT
Date & Time : 16.04.2007/9.0012.00 Dept. No. Max. : 100 Marks
PART A (5 X 4 = 20 marks)
Answer any FIVE questions in 75 words each. Each question carries FOUR marks.
 Explain the concepts of risk and return employed in portfolio management.
 What is a mutual fund? Give suitable examples.
 The current annual interest rate in India is 6% while its UK counterpart is 4%. The price of £1 in the spot market is Rs.85. Price a oneyear forward contract for the RupeePound exchange rate.
 Define the concept of excess return used in efficient market hypothesis.
 What are the three forms of market efficiency identified by Fama?
 State Paul Cootner’s pricevalue interaction model.
 Calculate expected return and the standard deviation of returns for a stock with the following probability distribution:
Condition returns (%) 
34 
18 
0 
20 
24 
26 
30 
Occurrence probability 
0.05 
0.15 
0.20 
0.20 
0.15 
0.15 
0.10 
PART B (4 X 10 = 40 marks)
Answer any FOUR questions in 250 words each. Each question carries TEN marks.
 Differentiate between forward/future contracts and options.
 What are factor models? How are they relevant for Arbitrage Pricing Theory?
 Present the various empirical evidences supporting market efficiency.
 Stocks A and B have yielded the following returns for the past three years:
Returns (%)
Stock 
2004 
2005 
2006 
A 
26 
20 
14 
B 
30 
24 
16 
 a) What is the expected return on a portfolio made up of 60% of A and 40% of B?
 b) Find out the standard deviation of each stock.
 c) What is the covariance and coefficient of correlation between A and B?
 d) What is the portfolio risk of the portfolio made up of A and B?
 Using a numerical example show how an interest rate swap can result in a winwin solution for the two parties to the swap contract.
 Consider the following single period binomial process for a given stock price.
The current stock price is $18 and with probability 0.5 this price will rise to $23.
With the complementary probability, the price will fall to $11. Assuming that the
riskfree rate is 9% and the exercise price is $15 determine the price of a one
period European call option and a oneperiod European put option.
 In the absence of arbitrage, derive the formula employed in the pricing of forward contracts.
PART C (2 X 20 = 40 marks)
Answer any TWO questions in 900 words each. Each question carries TWENTY marks.
 Explain the importance of ArrowDebreu securities, replicating portfolios and
arbitrage opportunities within the state preference model of asset pricing.
 What is portfolio management? Discuss the various functions of portfolio
management.
 a) Within the context of meanvariance analysis, explain the importance of
correlation, the efficient set, the riskfree asset and the tangency portfolio.
(10 marks)
 b) The following table presents the expected returns and standard deviations for
three stocks and the market index. The riskfree interest rate is 5% and the stock market is in CAPM equilibrium. (10 marks)
Name 
Expected Return

Standard Deviation

Brown plc

7% 
8% 
Cornelius plc 
12% 
19% 
Watkins plc 
15% 
26% 
Market index 
11% 
15% 
 i) What are the ‘beta’ values for each of the three stocks? Explain which
stock would be the best investment if the market was expected to rise?
 ii) What are the covariances of the returns of each of these stocks with the
returns on the market?
iii) What is the numerical equation of the capital market line (CML) for this
market? Identify whether the stocks plot on the CML and explain what
you conclude from this.
 a) The BlackScholes formula for the price of a European call option is derived
in a continuoustime framework. How do BlackScholes call option prices
depend on i) the exercise price, ii) the riskfree interest rate and iii) the
volatility of the underlying asset price? (10 marks)
 The current stock price of IOB is Rs.72. Both a call and a put option are
to be written on IOB’s equity with an expiry of 6 months and an exercise
price of Rs.70. Assume that volatility is 20% per annum and riskfree interest
rate is 10% per annum. Determine the price of the call and put options using
the BlackScholes model. (10 marks)
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