Suppose Mr. Zafar, (a habitualinvestor in stocks) has currently maintained a portfolio as
mentioned below:
Stock Companies Beta Returns
Standard
Deviation
A Lucky Petroleum 0.95 7.2% 0.12
B MJ Corporation 1.25 14.6% 0.15
C Venus Industries 1.15 9.3% 0.10
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His whole investment comprises of 10 million rupees, from which 32 percent was invested
in stock A and the rest was invested equally in stock B and C.
Risk and return specifications of this portfolio are as follows:
Beta 1.12
Return 10.4%
Variance 0.01
Standard deviation 0.09
* The correlation between AB is 0.75; AC is 0.35 and BC is -0.5*.
Now, Mr. Zafar is interested to extract his investment from stock C to further invest in
some other stock. For this purpose he is looking forward to investigate about two of the
potential opportunities prevailing in the market i.e:
I. Ghazi Company’s share (stock D) is available in the KSE at Rs. 40/- each. Company is paying
Rs. 5.6/- as dividend on each share with expected growth rate of 7.5%. Face Value of the share is
Rs.12/-. Risk free rate of return is 11%. Rate of return as per KSE Index is 14%; return on this
stock seems bit volatile as reflected by its beta i.e. 1.9.
II. Zamin Corporation’s share (stock E) is also available in KSE. Upon investigating its Price
Earnings (P/E) ratio, Mr. Zafar came to know that investors are willing to pay five rupees to
earn one rupee and industry average of P/E ratio is 6.5. Moreover, that the Company is paying
dividend of Rs. 28.5 per share which represents 30% of its earnings (EPS = Rs. 95) and the
dividend is expected to grow at 10% per year for foreseeable future. Mr. Zafar’s required rate of
return for this investment is 17%; while, the stock beta is 1.4.
His whole investment comprises of 10 million rupees, from which 32 percent was invested
in stock A and the rest was invested equally in stock B and C.
Risk and return specifications of this portfolio are as follows:
Beta 1.12
Return 10.4%
Variance 0.01
Standard deviation 0.09
* The correlation between AB is 0.75; AC is 0.35 and BC is -0.5*.
Now, Mr. Zafar is interested to extract his investment from stock C to further invest in
some other stock. For this purpose he is looking forward to investigate about two of the
potential opportunities prevailing in the market i.e:
I. Ghazi Company’s share (stock D) is available in the KSE at Rs. 40/- each. Company is paying
Rs. 5.6/- as dividend on each share with expected growth rate of 7.5%. Face Value of the share is
Rs.12/-. Risk free rate of return is 11%. Rate of return as per KSE Index is 14%; return on this
stock seems bit volatile as reflected by its beta i.e. 1.9.
II. Zamin Corporation’s share (stock E) is also available in KSE. Upon investigating its Price
Earnings (P/E) ratio, Mr. Zafar came to know that investors are willing to pay five rupees to
earn one rupee and industry average of P/E ratio is 6.5. Moreover, that the Company is paying
dividend of Rs. 28.5 per share which represents 30% of its earnings (EPS = Rs. 95) and the
dividend is expected to grow at 10% per year for foreseeable future. Mr. Zafar’s required rate of
return for this investment is 17%; while, the stock beta is 1.4.
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1) You need to find out the intrinsicvalue of stock D of Ghazi Company through using SML
equation.
2) With the help of given information, you need to calculate the intrinsic value of Zamin
Corporation’s share (stock E)? (5 marks)
3) Based on intrinsic values and information of both stocks (D and E), you need to recommend
that which investment opportunityMr. Zafar should opt? Give logical justification of your
recommendation. (3 marks)
4) Calculate portfolio’s beta, return, variance and standard deviationafter replacing stock C with
new recommended stock that is assumed to have standard deviationof 0.11. The correlation
between stocks is supposed to be AD 0 .25; AE 0.3; BD 0.5 & BE is 0.7. (13 marks)
5) Comment and justify that whether new portfolio is better or the previous one with respect to
risk and return context? (3 marks)
1) You need to find out the intrinsicvalue of stock D of Ghazi Company through using SML
equation.
2) With the help of given information, you need to calculate the intrinsic value of Zamin
Corporation’s share (stock E)? (5 marks)
3) Based on intrinsic values and information of both stocks (D and E), you need to recommend
that which investment opportunityMr. Zafar should opt? Give logical justification of your
recommendation. (3 marks)
4) Calculate portfolio’s beta, return, variance and standard deviationafter replacing stock C with
new recommended stock that is assumed to have standard deviationof 0.11. The correlation
between stocks is supposed to be AD 0 .25; AE 0.3; BD 0.5 & BE is 0.7. (13 marks)
5) Comment and justify that whether new portfolio is better or the previous one with respect to
risk and return context? (3 marks)
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