Capital Market and Portfolio Management December 2026

Q.1: A mid-cap Indian company has been experiencing low trading volumes and wide bid-ask spreads in its shares. At the same time, institutional investors are increasingly using algorithmic trading to execute large orders, while retail investors primarily use online discount-broker platforms.

As a Capital Market Consultant, analyse how market structure and trading mechanisms can influence the liquidity, price discovery and execution quality of such a security. In your response:

• Compare the roles of exchange-based and OTC markets;

• Evaluate the suitability of market orders, limit orders and stop-loss orders for different market participants;

• Analyse the role of liquidity and market depth in execution; and

• Evaluate how algorithmic trading can influence market efficiency and create risks for market participants.

Answer:

Introduction:

In capital markets the liquidity, price discovery and execution quality are significantly affected by the method of trading as well as by the various players in the market. For a mid-cap company in India with low trading volume and wide bid-ask spreads, these factors can be particularly challenging as it can be challenging for investors to purchase or sell the shares quickly without significantly affecting the share price. However, the exchange market is characterized by open-market price quotations and trading processes, while the OTC market is characterized by negotiations between the involved parties. Furthermore, the selection of the order type has a significant impact on the execution price and speed as a market order features high execution probability but limited price control, while a limit order provides higher level of price control but can remain unexecuted. While a Stop-loss order protects from any kind of loss, it is possible that it may be triggered by the movement in price. Hence, understanding the market structure, liquidity, the market depth and how the execution takes place is essential for analysing any security.

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Q.2 (A): During a sharp rise in the Indian stock market, a large number of retail investors begin purchasing a particular stock simply because "everyone is buying it." Some investors continue holding the stock despite deteriorating fundamentals because they fear realising a loss.

As an investment advisor, analyse the behavioural biases reflected in this situation and evaluate how such behaviour challenges the assumptions of the Efficient Market Hypothesis (EMH). Design two practical decision-making measures that investors could adopt to reduce the influence of these biases.

Answer:

Introduction:

When a stock market is experiencing a substantial upward movement, one may base purchase decisions on the beliefs and actions of other individual investors in order for him/her to be aligned with the general market trend. Meanwhile, persistent retention of a descending stock in order to prevent realisation of losses can be attributed to the common psychology of loss aversion. The characteristics of these two investor behaviours are key concepts in behavioural finance and simultaneously pose challenges to the Efficient Market Hypothesis (EMH).

Q.2 (B): Two diversified equity portfolios, Alpha Fund and Beta Fund, have generated the following annual performance:

The market return during the period was 12%.

Required:

a) Calculate the Sharpe Ratio and Treynor Ratio for both portfolios.

b) Based on the results, identify which portfolio provides better risk-adjusted performance under each measure and explain briefly why the rankings differ.

Answer:

Introduction:

Portfolio performance cannot be evaluated purely on the basis of the level of its returns. An investor’s attention should be paid to the amount and nature of risks undertaken while pursuing the performance. The Sharpe Ratio shows the extra return earned over the total risk taken, and the Treynor ratio represents the extra return earned against the systematic or market risk. Thus, it can be said that the Alpha Fund has a higher level of performance than the Beta Fund, although it also involves higher levels of volatility or total risk, and beta or market risk. By calculating the two ratios, it is possible to evaluate the performance of the two diversified equity funds and understand their level of compensation after adjusting the total and market risks.