### THURSDAY: 27 April 2023. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings. Do NOT write anything on this paper.

**QUESTION ONE**

1. An investment consultant firm has been appointed to advise Kedog Asset Managers on document management.

**Required:**

Discuss THREE areas of document management that the investment consultant should cover. (6 marks)

2. Peter Kamau has an investment capital of Sh.2,000,000. He wishes to invest in two securities; A and B in the following proportion; Sh.600,000 in security A and Sh.1,400,000 in security B.

The returns on these two securities depend on the state of the economy as shown below:

**Required:**

Compute:

The portfolio expected return. (3 marks)

The actual portfolio risk. (3 marks)

The weighted portfolio risk. (1 mark)

3. John Namu who is 65 years old, retired five years ago after a long career in the telecommunications industry. John and his wife Anastacia Wambura live in Kakamega County. His wife is now 63 years old and retired three years ago. Even though they are retired, they prefer to maintain their current lifestyle with spending needs of Sh.80,000 per year in real terms. Inflation is expected to be 3% with nominal risk free rate equal to 5%. John and Anastacia survival probabilities for the next two years are as shown below:

**Required:**

The probability that either John or Anastacia will survive for the next two years. (2 marks)

The real risk free rate that will be used to discount future cash flows. (2 marks)

Present value of core spending needs at the end of year two. (3 marks)

**(Total: 20 marks)**

**QUESTION TWO**

1. Highlight THREE assumptions of Fundamental law of active management. (3 marks)

2. With respect to Fundamental law of active management, distinguish between “information co-efficient (IC)” and “Transfer coefficient (TC)”. (4 marks)

3. An actively managed portfolio has a transfer coefficient (TC) of 0.60 and unconstrained information ratio of 0.35.

The benchmark portfolio has a Sharpe ratio of 0.45 and a risk of 20%

**Required**:

Determine the optimal amount of aggressiveness in the actively managed portfolio. (3 marks)

4. The returns on stock Z and market portfolio for a period of 5 years are as follows:

**Required:**

Calculate:

The beta of the security (4 marks)

The alpha of the security. (2 marks)

The security characteristic line. (1 mark)

The systematic risk. (2 marks)

The unsystematic risk. (1 mark)

**(Total: 20 marks)**

**QUESTION THREE**

1. Summarise FOUR practical limitations of the Capital Asset Pricing Model (CAPM). (4 marks)

2. In relation to program trading in portfolio management:

Explain the term “fintech”. (2 marks)

Describe THREE applications of fintech technology in the investment industry. (6 marks)

3. BB Investments Firm is in possession of two asset classes: long term bonds issued by Australian government and long-term Canadian government bonds. The expected monthly return on Australian bonds is 0.85% with a standard deviation of 3.2%.

Expected monthly return on Canadian bonds is 0.95% with a standard deviation of 5.26%: The portfolio’s market value is Sh.100 million and is equally weighted between the two asset classes.

**Additional information:**

1. There are 52 weeks in a year of 12 months.

2. Monthly portfolio variance is estimated at 0.001242.

**Required:**

Weekly portfolio return. (2 marks)

Weekly standard deviation. (2 marks)

5% weekly value at risk (VaR). (2 marks)

1% weekly VaR. (2 marks)

**(Total: 20 marks)**

**QUESTION FOUR**

1. Examine TWO differences between “macroeconomic factors” and “fundamental factors” in relation to multifactor models. (4 marks)

2. Milton Opiyo is a local investor who is keen in investing on various financial instruments. One of his key objectives is to maintain capital preservation by ensuring that after-tax returns on his wealth is maximised and if possible invest in products that are tax exempt.

As his appointed investment analyst, the following information has been availed to you:

1. A taxable investment with a yield of 9.5% per annum is available.

2. A risk-free treasury bill tax-exempt yielding 6.8% per annum is also available.

3. Income tax bracket for individual investors is currently at 30%.

**Required:**

Determine the after tax returns of the taxable security that Milton Opiyo could earn. (1 mark)

Advise Milton Opiyo on the gross interest that he must target to earn from the taxable investment in

order to earn the same rate as the tax exempt investment. (2 marks)

3. The Fanaka Pension Fund was valued at Sh.50 million at the start of the month and Sh.52,750,000 at the month end. During the month, there was a cash flow injection of Sh.380,000 on day 11 and Sh.220,000 injection on day 20. The valuation of the Fund account was Sh.52,335,000 and Sh.52,530,000 on day 11 and day 20 respectively.

**Required**:

Calculate the Time Weighted Rate of Return (TWRR) assuming 30 days in a month. (3 marks)

4. Lewis Guantai has been an investor in the securities exchange for the last five years. Lewis is planning to construct a minimum variance portfolio comprising the shares of two quoted companies; X Ltd. and Y Ltd.

Due to uncertainties surrounding the economic environment, he is projecting the shares returns under three macro- economic factors as follows:

**Required:**

The weight of security X and security Y in the minimum variance portfolio. (6 marks)

The expected return of the minimum variance portfolio. (2 marks)

The standard deviation for the minimum variance portfolio. (2 marks)

**(Total: 20 marks)**

**QUESTION FIVE**

1. Describe THREE ethical responsibilities that are expected of a portfolio manager. (3 marks)

2. Explain how the following changes could affect the relationship between risk and required rate of return for either an individual investment or group of investments:

A movement along the security market line (SML). (2 marks)

A change in the slope of the security market line (SML). (2 marks)

A shift in the SML. (2 marks)

3. Albert Korir uses the arbitrage pricing theory (APT) as a basis for evaluating the strategies he uses for the portfolio he manages.

The following data is available for the three funds:

Albert Korir believes that an arbitrage opportunity exists in fund C.

**Required:**

Calculate the expected return of the portfolio assuming a weighing of 50% for fund A and 50% for Fund B. (1 mark)

Calculate the expected return of the portfolio using a weighting of 60% for fund A. (1 mark)

Using your results in (c) (i) and (c) (ii) above, determine how the arbitrage opportunity may be exploited,

if any. (3 marks)

4. The following information relates to the two portfolios XYZ and QPT:

The risk free rate is 6% and the benchmark standard deviation is 12%.

**Required:**

For each portfolio, calculate the following measures of performance:

Sharpe measure. (2 marks)

Treynor measure. (2 marks)

Highlight two benefits of risk adjusted performance measures. (2 marks)

**(Total: 20 marks)**