THURSDAY: 8 December 2022. 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.


1. Explain THREE behavioural factors that affect portfolio construction. (6 marks)

2.  Johnson Sakwa and Alex Mwiti both have Sh.100,000 each split evenly between a tax deferred account and a taxable
account. Johnson Sakwa chooses to put shares with an expected rate of return of 7% in the tax deferred account and
bonds yielding 4% in the taxable account. Alex Mwiti chooses the reverse, putting shares in the taxable account and
bonds in the deferred account as follows.

Additional information:

1. When held in taxable account, equity returns will be taxed entirely as capital gains at a 5% rate while interest income is taxed annually at 15%.
2. The tax rate applicable to withdrawals from the tax deferred account will be 30%.
3. Cost basis is equal to market value on asset held in taxable account.


Calculate the after tax accumulation after 20 years for:

Johnson Sakwa. (3 marks)

Alex Mwiti. (3 marks)

3. Nancy Wafula estimates that her revised annual living expenses including a new studio and an apartment will average Sh.132,500 (excluding her child education costs). If necessary, she could combine her apartment and studio to reduce spending by Sh.32,500. She does not want her financial security to be dependent on further gifting from her parents and is pleased that, after the sale of Sawa apartment, she will be able to meet her new living expenses with proceeds from art sales amounting to Sh.50,000 and the expected total return of the proposed investment portfolio of Sh.82,500. Because of the uncertainty of art sales, Nancy plans to establish an emergency reserve fund equal to one year’s living expenses. Her after tax proceeds from the sale of Sawa apartment are expected to be Sh.1,200,000 (1 – 0.15) = Sh.1,020,000. She also holds Sh.75,000 in balanced mutual funds and Sh.25,000 in a money market fund. Nancy intends to revaluate her policy statement and asset allocation guidelines every three years.


Discuss Nancy’s liquidity requirements. (4 marks)

Determine Nancy’s return requirement. (2 marks)

Evaluate whether Nancy’s portfolio can satisfy that requirement if inflation average 3% annually and she reduces her annual living expenses to Sh.100,000 by combining her apartment and studio. (2 marks)

(Total: 20 marks)


1. Propose THREE key trends in the global asset management industry. (6 marks)

2. Explain THREE differences between individual investors and institutional investors. (6 marks)

3. Two assets A and B are known to lie on the security market line (SML). Asset A has a beta of 0.5 and a risk premium of 4%. Asset B has an expected rate of return of 20% and a beta of 1.75. You are considering the following securities which are available in the market:
Security Expected return (%) Beta
A 20 2.00
B 14 0.75
C 15 1.25
D 12 –0.25
E 31 3.25


Determine the risk free rate of return. (2 marks)

Calculate the required rate of return of each security. (4 marks)

Identify which security is undervalued, overvalued or correctly valued. (2 marks)

(Total: 20 marks)


1. Describe TWO approaches for undertaking stress testing in portfolio risk management. (4 marks)

2. The following data relates to portfolio L return:

The risk free rate is 1%.

Calculate portfolio L Sortino ratio. (4 marks)

3. Michael Bundi wants to invest in stock market. He has gathered the following information about individual securities:

The market variance is 10% and the risk free rate is 7%.


Excess return to beta ratio. (4 marks)

Cut-off point. (6 marks)

Optimum portfolio assuming no short sales. (2 marks)

(Total: 20 marks)


1. Explain the following types of asset allocation:

Tactical asset allocation. (2 marks)

Dynamic asset allocation. (2 marks)

Insured asset allocation. (2 marks)

2. Highlight SEVEN stages of a typical client interaction cycle with respect to documentation. (7 marks)

3. The following information relates to the market price per share of Nebo Limited over a period of five years:


The expected return of the shares of the company. (5 marks)

Comment on the performance of the company based on the movement of its share price over the last five years. (2 marks)

(Total: 20 marks)


1.  Simon Mwakirungo is an investment manager of Heko Investment Ltd. Simon manages portfolio of three investors; Paul Wafula, Stephen Nabukwesi and Solomon Njoroge. Paul, Stephen and Solomon has risk aversion coefficient of 1, 0 and –1 respectively.

Identify the risk category of each investor, giving ONE reason. (6 marks)

2. James Mwathi is a market timer who makes monthly asset allocation decisions. His decisions are based on his forecast of the direction of the market. James Mwathi’s forecast are right 72% of the time. James normally constructs unconstrained portfolio.

The information ratio for James Mwathi. (4 marks)

3. The following information is available for Milele fund for the year 2021:
1. On 1 January 2021, Milele fund had a market value of Sh.100 million.
2. During the period, 1 January 2021 to 30 April 2021, the stock in the fund showed a capital gain of Sh.10 million.
3. On 1 May 2021, the stocks in the fund paid a total dividend of Sh.2 million. All dividends were reinvested in additional shares.
4. As the fund performance has been exceptional, investors invested an additional Sh.20 million in the fund on 1 May 2021.
5. On 31 December 2021, the fund received total dividends of Sh.2.64 million. The fund’s market value on 31 December 2021, not including the Sh.2.64 million in dividends was Sh.140 million.
6. The fund made no other interim cash payments during the year 2021.


The time weighted rate of return (TWRR). (4 marks)

The money weighted rate of return (MWRR). (4 marks)

Outline TWO differences between time weighted rate of return and money weighted rate of return. (2 marks)

(Total: 20 marks)

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