# You have to demonstrate the impact of diversification on the portfolio returns and variance in case of two assets

Capital Market and Portfolio Management

Q.1 Following information regarding the holding period of the stock A, is available. Based on the data provided in the Table 1 below, calculate and mention the following

i. Return on Investment (ROI) and its Formulae

ii. Steps to calculate ROI

iii. Net Returns from investment (in Rs)

Table 1

 Stock A Event Date Value (In Rs.) Stock Purchased 31 March 2012 750.60 Dividend received 31 March 2013 9.00 Dividend received 31 March 2014 9.50 Dividend received 31 March 2015 10.00 Dividend received 31 March 2016 10.50 Dividend received 31 March 2017 11.00 Stock Sold 31 March 2017 1,320.90

Q.2 Mr. Ravindra Kumar chooses to invest total amount of Rs. 1,00,000/- in equal proportion in both Stock A and B (data given in Table 2). The correlation coefficient between the stock A and stock B is 0.4. Demonstrate that he has taken a better investment decision as compared to decision of investing all the amount only in stock A and stock B.

Hint: You have to demonstrate the impact of diversification on the portfolio returns and variance in case of two assets

Table 2

 Stock A Stock B Probability Return Probability Return 5% -20% 10% -25% 20% 0% 20% 0% 25% 10% 25% 20% 30% 20% 20% 30% 20% 25% 25% 40%

Q.3 Mr. Rajendra Kumar has been a investing in the stock market purely based on tips received from his stock-broker friend, Mr. Ramesh Chandra, and has been generating decent returns till now. Given the low size of his investible surplus, he has not been able to take advantage of all the tips that he received given by Mr. Ramesh, say during a year. As a result his investment has been restricted to investing mostly in a single company through a particular year. So much so that sometimes he has stayed invested in a single scrip even for more than two years. While his returns may have been sometimes good and sometimes great but he has not been overly worried about their levels or adequacy, as he has never lost any money at overall investment level. Actually the yearly returns from his stock market investments have always been higher than the bank fixed deposit returns, where he parks most of his savings. Hence, in nutshell, for him the investment strategy seems to be working for him and he is happy. Thus he never saw any reason to change his investment pattern or strategy. Moreover he continues to significantly rely on the tips received through Mr. Ramesh. Because of Mr. Ramesh’s good track record in suggesting good scrips for investment and the trust Mr. Rajendra has in Ramesh’s integrity, he has never acted on any of the tip related to investments received from any other person.

Last week Mr. Ramesh told him that he plans to retire from his stock broking business. He planned to handover the business over the next six months, to his partner and relocate with his wife, permanently to US to stay with his son and his family. He added that while Mr. Rajendra can continue to avail of the broking services through the broking firm to be run by his partner, he will not be able to provide the good and timely tips that Mr. Rajendra has been solely relying on for investing his money. He also suggested Mr. Rajendra to invest through mutual funds.

Mr. Rajendra got worried and told Mr. Ramesh that he is not convinced that why he should be investing through a mutual fund. Moreover, even if he agrees to invest through the same, how would he ever choose the one that he should give his money to invest, as there are so many of them with each one claiming their performance to be better than the other?

Understanding Mr. Rajendra’s predicament and anxiety, Mr. Ramesh gave reference of one of his professional contact (You), working as a fund manager, in a reputed mutual fund company. He asked Mr. Rajendra to meet you and seek answers to his questions related to mutual funds. Mr. Rajendra has contacted you and sought time to meet with you and discuss the following:

a) Why should Mr. Rajendra be investing through mutual fund?

b) On what basis he should choose a mutual fund amongst others? What are the various performance measures used for a mutual fund?