SAPM Solved Papers May' 2013, Dibrugarh University B.Com 4th/6th Sem

Security Analysis and Portfolio Management Solved Question Paper May 2013 
2013 (May)
COMMERCE (Speciality)
Course: 404 (Security Analysis and Portfolio Management)
Full Marks: 80
Pass Marks: 32 Marks (Old Course)
Time: Three hours
The figures in the margin indicate full marks for the questions

1. State the difference between the followings:

a) Investment and expenditure

Ans: Investment is the employment of funds with the aim of getting return on it.

Expenditure is the employment of funds to acquire any asset for use.

b) Risk and uncertainty

Ans: Risk may be described as variability/fluctuation/deviation of actual return from expected return from a given asset/investment.

Uncertainty cab be defined as the inability to forecast future events.

c) Concentration of securities and diversification of securities

Ans: Investment in some specific sector stocks are called concentration of securities.

Diversification means investment in different sector stocks.

d) Markowitz model and CAPM model

Ans: Markowitz theory states that by combining a security of low risk with another security of high risk, success can be achieved by an investor in making a choice of investments.

Capital market theory is an extension of the Portfolio theory of Markowitz. The portfolio theory explains how rational investors should build efficient portfolio based on their risk-return preferences. Capital Market Asset Pricing Model (CAPM) incorporates a relationship, explaining how assets should be prices in the capital market.

e) Investor and speculator

Ans: Investors are long term investment believer having faith in the economy and company’s future prospects.

Speculators are short term traders who wants to make profits by taking the advantage of price fluctuation in stocks.

f) Systematic risk and unsystematic risk

Ans: Systematic Risk: Systematic Risk refers to that portion of total variability (risk) in return caused by factors affecting the prices of all securities. Economic, political, and sociological changes are the main sources of systematic risk.

Unsystematic risk: Unsystematic Risk refers to that portion of total risk that is unique or peculiar to a firm or an industry, above and beyond that affecting securities markets in general. Factors like consumer preferences, labour strikes, management capability etc. cause unsystematic risk (variability of returns) for a company’s stock.

g) Treynor’s index and Sharpe’s index

Ans: Treynor used beta as the risk measure to capture the volatility of the portfolio relative to the market.

Sharpe used standard deviation as the risk measure to capture the overall risk of the portfolio.

h) Call option and Put option

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2. Write short notes on the following (any four)

a) Convertible securities

Ans: A convertible security is a type of security, usually a bond or a preferred stock, that can be converted into a different form of security, normally equity shares. Convertible securities include convertible debentures (CDs), convertible pref. Shares (CPs), etc. CDs can be partly or fully or optionally convertible into equity shares. CPs can be similarly partly, fully or optionally convertible.

Convertible securities give the investor initially fixed return and later on conversion might give capital gain. When a company issues convertible bond, the conversion date, the conversion price, the conversion ratio, etc. must be indentured. So, a company issues convertible bonds of Rs. 60 each, convertible into 3 shares are exchanged. The conversion price is, the face value of the bond divided by conversion ratio, i.e., Rs. 60/3 = Rs. 20. If only the market price of the equity shares is > 20, conversion will be effected. The market value of the convertible bond does not affect the conversion will be affected. The market value of the convertible bond does not affect the conversion price or conversion ratio. The conversion ratio will be set, such that, it is not lucrative to convert immediately. Say the current price of the share is Rs. 22. Then the conversion value of the bond at this point of time is 3 x 22 = Rs. 66. Say the bond goes at Rs. 70 in the market. Then, the conversion premium is said to be Rs. 4 (i.e., Rs.70 – Rs. 66). As long as conversion premium exists, conversion will not take place. To force conversion, the company may exercise call provision and call the bonds for redemption, say at its face value of Rs. 60. The holders of the convertible bond will go for conversion as that gives Rs. 6 more than call route redemption.

b) Assumptions of Markowitz model

Ans: ASSUMPTIONS OF MARKOWITZ’S MODEL

a)       The markets are efficient and absorb all the information quickly and perfectly. So an investor can earn superior returns either by technical analysis or fundamental analysis. All the investors are in equal category in this regard.

b)      Investors are risk averse. Before making any investments, all of them, have a common goal-avoidance of risk. But practically this assumption does hold good. In a country like India, majority of investors invests money on the basis of market news without doing any technical and fundamental analysis.

c)       Investors are rational. They would like to earn the maximum rate of return with a given level of income or money.

d)      Investors base their decisions solely on expected return and variance (or standard deviation) of returns only.

e)      For a given risk level, investors prefer high returns to lower returns. Similarly, for a given level of expected return, they prefer less risk to more risk.

f)        The investor can reduce the risk if he adds investments to his portfolio.

g)       Investors consider each investment alternative as being represented by a probability distribution of expected returns over some holding period.

h)      A portfolio of assets under the above assumptions is considered to be efficient if no other portfolio of assets offers higher expected return with the same (or lower) risk or lower risk with the same (or higher) expected return.

c) Security market line

Ans: Security market line (SML) is the representation of the Capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk (its beta). It is also referred to as the "characteristic line".

The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML. The security market line is a useful tool in determining whether an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security's risk versus expected return is plotted above the SML, it is undervalued because the investor can expect a greater return for the inherent risk. A security plotted below the SML is overvalued because the investor would be accepting less return for the amount of risk assumed.

d) Jensen’s measures

Ans: Jensen's model proposes another risk adjusted performance measure. This measure was developed by Michael Jensen and is sometimes referred to as the Differential Return Method. This measure involves evaluation of the returns that the fund has generated vs. the returns actually expected out of the fund given the level of its systematic risk. The surplus between the two returns is called Alpha, which measures the performance of a fund compared with the actual returns over the period. Required return of a fund at a given level of risk (b) can be calculated as:

R_t – R = a + b (R_m – R)

Where, R_t = Portfolio Return

R = Risk less return

a = Intercept the graph that measures the forecasting ability of the portfolio manager.

b = Beta coefficient, a measure of systematic risk

R_m = Return of the market portfolio

Thus, Jensen’s equation involves two steps:

(i) First he calculates what the return of a given portfolio should be on the basis of b, R_m and R.

(ii) He compares the actual realised return of the portfolio with the calculated or predicted return. Greater the excess of realised return over the calculated return, better is the performance of the portfolio.

Limitation of this model is that it considers only systematic risk not the entire risk associated with the fund and an ordinary investor cannot mitigate unsystematic risk, as his knowledge of market is primitive.

e) Risk of buying and selling options (Out of Syllabus)

3. (a) Discuss the various fundamental analysis required for any investment with examples.

Ans: Fundamental analysis is method of finding out the future price of a stock which an investor wishes to buy. Fundamental analysis is used to determine the intrinsic value of the share of a company to find out whether it is overpriced or underpriced by examining the underlying forces that affect the well-being of the economy, Industry groups and companies.

Fundamental analysis is simply an examination of future earnings potential of a company, by looking into various factors that impact the performance of the company. The prime objective of a fundamental analysis is to value the stock and accordingly buy and sell the stocks on the basis of its valuation in the market. The fundamental analysis consists of economic, industry and company analysis. This approach is sometimes referred to as a top-down method of analysis.

Types of fundamental analysis to be done before making Investment

The actual value of a security, as opposed to its market price or book value is called intrinsic value. The intrinsic value includes other variables such as brand name, trademarks, and copyrights that are often difficult to calculate and sometimes not accurately reflected in the market price. One way to look at it is that the market capitalization is the price (i.e. what investors are willing to pay for the company and intrinsic value is the value (i.e. what the company is really worth). The fundamental analysis consists of economic, industry and company analysis. This approach is sometimes referred to as a top-down method of analysis.

a)       At the economy level, fundamental analysis focus on economic data (such as GDP, Foreign exchange and Inflation etc.) to assess the present and future growth of the economy.

b)      At the industry level, fundamental analysis examines the supply and demand forces for the products offered.

c)       At the company level, fundamental analysis examines the financial data (such as balance sheet, income statement and cash flow statement etc.), management, business concept and competition.

a)      ECONOMIC ANALYSIS: Economic analysis occupies the first place in the financial analysis top down approach. When the economy is having sustainable growth, then the industry group (Sectors) and companies will get benefit and grow faster. The analysis of macroeconomic environment is essential to understand the behavior of the stock prices. The commonly analysed macro-economic factors are as follows:

a)      gross domestic product (GDP) growth rate

b)      exchange rates

c)       balance of payments (BOP)

d)      current account deficit

e)      government policy (fiscal and monetary policy)

f)        domestic legislation (laws and regulations)

g)       unemployment rates

h)      public attitude (consumer confidence)

i)        inflation

j)        interest rates

k)       productivity (output per worker)

l)        Capacity utilisation (output by the firm).

b)      INDUSTRY OR SECTOR ANALYSIS: The second step in the fundamental analysis of securities is Industry analysis. An industry or sector is a group of firms that have similar technological structure of production and produce similar products. These industries are classified according to their reactions to the different phases of the business cycle. They are classified into growth, cyclical, defensive and cyclical growth industry. A market assessment tool designed to provide a business with an idea of the complexity of a particular industry. Industry analysis involves reviewing the economic, political and market factors that influence the way the industry develops. Major factors can include the power wielded by suppliers and buyers, the condition of competitors and the likelihood of new market entrants. The industry analysis should take into account the following factors.

a)       Characteristics of the industry

b)      Demand and market for the product.

c)       Government policy

d)      Labour and other industrial problems exist or not.

e)      Capabilities of management.

f)        Future prospects of the industry

c)       COMPANY OR CORPORATE ANALYSIS: Company analysis is a study of variables that influence the future of a firm both qualitatively and quantitatively. It is a method of assessing the competitive position of a firm, its earning and profitability, the efficiency with which it operates its financial position and its future with respect to earning of its shareholders. This analysis can be done with the help of financial statements.

Or

(b) Why the technical analysis important in portfolio development? Explain with examples.

Ans: In fundamental analysis, a value of a stock is predicted with risk-return framework based on economic environment. An alternative approach to predict stock price behaviour is known as technical analysis. It is frequently used as a supplement rather than as a substitute to fundamental analysis. Technical analysis is based on notion that security prices are determined by the supply of and demand for securities. It uses historical financial data on charts to find meaningful patterns, and using the patterns to predict future prices.

In the words of Edwards and Magee: “Technical analysis is directed towards predicting the price of a security. The price at which a buyer and seller settle a deal is considered to be the one precise figure which synthesizes, weights and finally expresses all factors, rational and irrational quantifiable and non-quantifiable and is the only figure that counts”.

Charting represents a key activity for a technical analyst during individual stock analysis. The probable future performance of a stock can be predicted and evolving and changing patterns of price behaviour can be detected based on historical price-volume information of the stock. Charts used to study the trend in prices, price index, and also volume of transactions. Technical analysis involves three basic types of charts. They are:

(a) Line charts,

(b) Bar charts, and

(3) Point and figure charts.

a)       A Line Chart connects successive trading day’s closing price/price indices or volume of trade as the case may. Each day’s price is recorded.

b)      A Bar Chart is made up by a series of vertical bars of lines, each bar of line representing; a particular day’s high and low prices. The closing price of a day is indicated by a small horizontal dash on the day’s bar. Each day’s price data are thus recorded.

c)       Point and figure charts are more complex than line and bar charts. Point and figure chart are not only used to detect reversals in a trend, but also used to forecasts the price, called price targets. The only significant price changes are posted to point and figure charts. Three or five-point price changes as posted for high prices securities, only one point changes are posted follow prices securities. While line and bar charts have two dimensions with vertical column indicating trading day, point and figure chart represents each column as a significant reversal instead of a trading day. For example, for a share in the price hand of Rs. 1000-1500 or so, a price change exceeding, say, Rs. 15 may be taken as significant, whereas for a scrip in the price range of Rs. 100-150, a change in price of the order of Rs. 3 or more may be taken as significant. Upward significant moves are indicated by ‘x’ in the same column. Say for scrip of Rs. 3 change is taken as significant. Another ‘x’ in the same column, above the previous ‘x’ is put. The same day it moves to 107. One more ‘X’ is put. Next day price drifts by Rs. 2. No entry in price will he recorded in this column. If a significant increase in price takes place, next column of ‘x’ will be charted.

Advantages of technical analysis

1)      Simple and quick: Technical analysis is simple and quick method on forecasting behaviour of stock prices.

2)      Helps in identifying trend: Under the influence of crowd psychology, trends persist for quite some time. Tools of technical analysis that help in identifying these trends early are helpful in investment decision-making.

3)      Short term price prediction: Technical analysis try to predict short term market price which is useful for speculators who want to make quick money.

4)      Tracking shift in demand and supply: Shifts in demand and supply are gradual, not instant. Technical analysis helps in detecting these shifts rather early and hence provides clues to future price movements,

5)      Price movement analysis: Fundamental information about a company is absorbed and assimilated by the market over the period of time. Hence, the price movement tends to continue in more or less in the same direction till the information is fully assimilated in the market.

6)      Price prediction: Charts provide a picture of what has happened in the past and hence give a sense of volatility that can be expected from the stock. Further, the information on trading volume, which is ordinarily provided at the bottom of a bar chart, gives a fair idea of the extent of public interest in the stock.

7)      Superior than fundamental analysis: According to technical analysts, their method is far superior than the fundamental analysis, because fundamental analysis is based on financial statements which themselves are plagued by certain deficiencies like subjectivity, inadequate disclosure etc.

4. (a)Discuss the effect of combining securities in portfolio. Why is diversification of securities preferred in portfolio construction?

Ans: Effects of combining two securities

Portfolio: A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly tradable securities, like real estate, art, and private investments.

Portfolio analysis deals with the determination of future risk and return in holding various combinations of individual securities. The portfolio expected return is the weighted average of the expected returns, from each of the individual securities, with weights representing the proportionate share of the security in the total investment. The portfolio expected variance, in contrast, can be something less than a weighted average of security variances. Therefore, an investor can sometimes reduce risk by adding another security with greater individual risk compared to any other individual security in the portfolio.

It is believed that holding two securities is less risky than having only one investment in a person’s portfolio. When two stocks are taken on a portfolio and if they have negative correlation, then risk can be completely reduced because the gain on one can offset the loss on the other.

The effect of two securities can also be studied when one security is riskier when compared to the other security.  As per Markowitz, given the return, risk can be reduced by diversification of investment into a number of securities. The risk of any two securities is different from the risk of a group of two companies together. Thus, it is possible to reduce the risk of a portfolio by incorporating into it a security whose risk is greater than that of any of scrips held initially.

Example: Given two securities A and B, with B considerably less risky than A, a portfolio composed of some of A and some of B may be less risky than a portfolio composed of only less risky B. Let:

	A	B
Expected Return Risk (σ) of security	40% 15%	30% 10%

 

Coefficient of correlation, between A and B can have any of the three possibilities i.e. -1, 0.5 or+1. Let us assume, investment in A is 60% and in B 40% Return on Portfolio = (40 X 0.6) + (30 X 0.4) = 36% Risk on Portfolio = (15 x 0.6) + (10 x 0.4) = 13%, Which is normal risk.

Moreover, when two stocks are taken on portfolio and if they have negative correlation, the risk can be completely reduced, because the gain on one can offset the loss on the other. The effect of two securities can also be studied when one security is more risk as compared to the other security.

Importance of Diversification in Portfolio Management

Diversification of investments is significant due to the following reasons:

1. Reduce the risk: Every stock or financial instrument carries some amount of risk with it except the risk-free investments. With portfolio diversification, one cannot completely remove the risks but can reduce the risk to a great extent. Without proper diversification amongst the different classes of the assets, the risk of investment rises with every investment we make. One needs to include both risky asset classes such as high- return generating stocks and to hedge their risk they should invest in fixed income assets. Diversification gradually reduces the risk of the portfolio over time.

2. Helps In Hedging: If investments are entirely made in stock market, then in case of excessive volatility the return on investments will dropped significantly. However, if they investors kept a certain amount of other investment assets like commodities, bonds, metals in their portfolio, their profits would have been higher because loss or low profits of the stock market would have been wiped off by the positive returns of the commodities market. Diversification helps in achieving desired or better returns even when the market is slow as there are other markets which make up for the negative or low yields of the former market. This way investors can hedge their investments and earn potential returns through portfolio diversification.

3. Provide Higher Returns: Since the market keeps on changing, we need to diversify with asset classes which are not correlated. Correlation plays the most critical role in determining returns. If we are investing in one market which is connected to the other, when the former goes down, that will substantially affect the other. We need to choose investment vehicles which are entirely different from each other. That’s why we need a diversified portfolio.

4. Aligning Portfolio With Financial Aspirations: As per the Behavioural portfolio theory, either our investment will give us the potential for high-growth, or it will protect from negative returns. This theory states that when a portfolio is diversified, it corresponds to a pyramid structure. A properly diversified portfolio has the maximum of low-risk investments and provides value growth and steady income generation. ‘Blend’ funds comprise the top of this pyramid which is a mix of risky and low-risk investment instruments. The regular income generating investments will provide with periodic income, and the blend funds will grow in value, and together they bring stability of investment and higher wealth accumulation.

5. Investment Mix Adjustment: Portfolio diversification allows us to modify investment mix as per changing financial needs and market changes. With age, the investment mix also needs to be changed as the tenure for investments keeps on reducing. While we start off with high-risk investment instruments, with time flowing, we must reduce our risk by shifting more towards fixed income financial instruments for regular earnings. While an investor of 20’s age group can assign 90% of his investment into stocks, investor of 50’s age group must have not more than 40% allocated to equities. That’s why we need a diversified portfolio.

Or

(b) Simron holds portfolio of two companies A and B with the following details:

Under the Markowitz model, what are the portfolio return and portfolio risk?

5. (a) Explain the arbitrage pricing theory (APT) and its limitation.

Ans: Arbitrage Pricing Theory (APT)

Arbitrage Pricing Theory (APT) is an alternate version of Capital Asset Pricing Model (CAPM). This theory, like CAPM provides investors with estimated required rate of return on risky securities. It is a multifactor mathematical model used to describe the relation between the risk and expected return of securities in financial markets. It computes the expected return on a security based on the security’s sensitivity to movements in macroeconomic factors. The resultant expected return can then be used to price the security.

The Arbitrage pricing theory based model aims to do away with the limitations of one factor model (CAPM) that different stocks will have different sensitivities to different market factors which may be totally different from any other stock under observation. In layman terms, one can say that not all stocks can be assumed to react to single and same parameter always and hence the need to take multifactor and their sensitivities. The formula includes a variable for each factor, and then a factor beta for each factor, representing the security’s sensitivity to movements in that factor. A two-factor version of the arbitrage pricing theory would look like as:

r = E(r) + B₁F₁ + B₂F₂ + e 

r = return on the security

E(r) = expected return on the security

F₁ = the first factor

B₁ = the security’s sensitivity to movements in the first factor

F₂ = the second factor

B₂ = the security’s sensitivity to movements in the second factor

e = the idiosyncratic component of the security’s return

As the formula shows, the expected return on the asset/stock is a form of liner regression taking into consideration many factors that can affect the price of the asset and the degree to which it can affect it i.e. the asset’s sensitivity to those factors.

If one is able to identify a single factor which singly affects the price, the CAPM model shall be sufficient. If there are more than one factor affecting the price of the asset/stock, one will have to work with a two factor model or a multi factor model depending on the number of factors that affect the stock price movement for the company.

Limitations of Arbitrage Pricing Theory:

a)       Problems in listing of various factors: The model requires listing of factors that have impact on the stock under consideration. Finding and listing all factors can be a difficult task and there is a risk that some or the other factor being ignored. Also risk of accidental correlations may exist which may cause a factor to become substantial impact provider or vice versa.

b)      Expected return of various factors: The expected returns for each of these factors will have to be arrived at, which depending on the nature of the factor, may or may not be easily available always.

c)       Difficult to measure Sensitivities of factors: The model requires calculating sensitivities of each factor which again can be a tedious task and may not be practically possible.

d)      Change in factors from time to time: The factors that affect the stock price for a particular stock may change over a period of time. Moreover, the sensitivities associated may also undergo shifts which need to be continuously monitored making it very difficult to calculate and maintain.

e)      Existence of arbitrage is essential: The APT model will prevail only if there is a opportunity of arbitrage. If arbitrage opportunity is not available, then this model does not prevail.

f)        Uncertain size or sign of factors: APT makes no statement about the size of sign of the factors.

g)       Unrealistic assumption: It is based on some assumptions which are not practical.

Or

(b) Calculate the equilibrium rate of return for the following three securities:

6. (a) Rank the following portfolios on the basis of Sharpe’s index and Treynor’s index:

Or

(b) Explain the different methods of measurement of portfolio performance.

Ans: Portfolio performance evaluation can be defined as a feedback and control mechanism which is used by the portfolio managers and investment analysts to make the process of portfolio/investment management more effective. Expert Portfolio managers have to show superior performance over the market; for that they have to evaluate their performance in comparison with other portfolio managers. Portfolio manager have an objective to achieve an optimum risk return adjustment. Whether they are heading towards this objective or not will be found out only if they evaluate their portfolios periodically. However, in conducting such an evaluation, a means for determining the appropriate standard or benchmark must be established. Two major factors which influence the performance are the rate of return earned and the associated risk over the relevant period. The return is defined to include changes in the value of the fund over the performance period plus any income earned over that period. Risk is the variability surrounding the return. The manager has to diversify completely into different industries, assets and instruments so as to reduce the unsystematic risk to the minimum for a given level of return. The systematic or market related risk has to be managed by a proper selection of beta for the securities.

Methods of assessing performance

The portfolio performance is evaluated by measuring and comparing the portfolio return and associated risk and hence risks adjusted performance. For this purpose, there are essentially three major methods of assessing performance:

a)       Return per unit of risk.

b)      Differential return.

c)       Components of performance.

a)       Return per Unit of Risk: The first measure of risk adjusted performance assesses the performance of a fund in terms of return per unit of risk; both in absolute terms and relative terms (relative to overall market performance). According to this measure, funds that provide the highest return per unit of risk would be adjudged as the best performers and the funds that provide the lowest return per unit of risk would be the poorest performers. There are two methods of determining the return per unit of risk.

Ø  Reward to volatility ratio developed by William Sharpe and

Ø  Reward to volatility ration developed by Jack Treynor.

Evaluation has also to take into account whether the portfolio is securing above average returns, average returns or below average returns as compared to the prevailing rate of return in the market. The ability of the fund managers to diversity can reduce and even eliminate all unsystematic risk. They can manage the systematic risk by use of appropriate risk measures, namely Betas. The portfolio managers must have superior timing and superior stock selection to earn above average returns. Diversification can reduce the market related risk and maximize the returns for a given level of risk. As the market returns are positively related to risk, the evaluators must take into consideration (a) The rate of returns, (b) Excess return over risk free rate, (c) Level of systematic, unsystematic and residual risk through proper diversification.

b)      Differential Return: Another method to measure the risk adjusted performance is the differential return measure. This measure was developed by Michael Jensen. The basic objective of this technique is to calculate the return that should be expected for the fund given the realized risk of the fund and then comparing the calculated return with the actually realized return. In making this comparison, it is assumed that the investor plays a very passive role. He merely buys the market portfolio and adjusts for the appropriate level of risk by borrowing or lending at the risk free rate.

c)       Components of Performance: The first two measures stated above are primarily concerned with the overall performance of a fund. However, the more useful measure would be to assess the sources and components of performance by developing a more refined breakdown. E. Fama has provided an analytical framework to have a more detailed breakdown of the performance of the fund. This break down is done in the following three ways:

1.       Stock Selection: Overall performance of the fund can be examined in terms of superior or inferior stock selection and the normal return associated with a given level of risk. Thus, Total Excess Return = Selecting + Risk.

To earn average returns, the fund managers have to diversify. The market pays returns only on the basis of systematic risk. The level of diversification can be judged on the basis of the correlation between the portfolio returns and the returns for a market portfolio. A completely diversified portfolio is perfectly correlated with the market portfolio, which is in turn completely diversified.

To earn the above average return, fund managers will generally have to forsake some diversification that will have its cost in terms of additional portfolio risk. Hence some additional return is needed for this additional diversification risk. Capital Market Line (CML) helps in determining the risk commensurate with the incurred risk.

2.       Market Timing: If investors want to maximize their returns, they must not only purchase the right security but must also know the right time to purchase and sell. To generate superior performance better than the market average, markets, have to be timed correctly. Market timing implies assessing correctly the direction of the market, either bull or bear and positioning the portfolio accordingly. When there is a forecast of declining market, the managers should position the portfolio properly by increasing the cash percentage of the portfolio or by decreasing the beta of the equity portion of the portfolio. When the forecast is of rising market, the managers should decrease the cash position or increase the beta of the equity portion of the portfolio.

3.       Cash Management Analysis: Cash management analysis was used by Farrell to assess the degree to which variations in the cash percentage around the long term average have benefited or detracted from fund performance. Two indexes were constructed for each fund by Farrell:

Ø  The first index is based on the average cash to other asset allocation experienced by the fund over the period of analysis.

Ø  The second index is based on a quarter to quarter changes experienced by the fund over the period.

7. (a) What do you mean by option? what are the silent features of option? Explain. (Out of Syllabus)

Or

(b)  What do you mean by futures? Discuss the unique characteristics of future trading.