Capital Market and Portfolio Management DEC 2025

Description

Capital Market and Portfolio Management

Dec 2025 Examination

 

 

Q1. A wealth management firm is advising a new client, Ms. Rao, who has recently inherited a significant sum and wants to invest in the capital market. She is unfamiliar with the concepts of risk and return, and is particularly concerned about market volatility. The firm”s portfolio manager must explain the differences between CML and SML, and demonstrate how these models can be used to construct a portfolio that aligns with Ms. Rao”s moderate risk tolerance and long-term financial goals. The manager must also address how systematic and unsystematic risks can be managed through diversification and model selection. Based on the scenario, how should the portfolio manager apply the Capital Market Line (CML) and Security Market Line (SML) concepts to construct an optimal portfolio for a client who seeks to balance risk and return, considering both systematic and unsystematic risks? (10 Marks)

Ans 1.

Introduction

Ms. Rao, a newly inherited investor, represents a common profile in wealth management—someone with financial potential but limited understanding of capital market risks. Her concerns about volatility are valid because stock markets fluctuate due to both systematic and unsystematic factors. To guide her effectively, the portfolio manager must use fundamental models like the Capital Market Line (CML) and the Security Market Line (SML), both of which offer structured ways to understand risk–return trade-offs. CML explains how risk can be managed through a Fully solved you can download

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Q2. Investor invests his fund 60% in asset A & 40% in asset B.

Expected return of asset A = 9.95%

Expected return of asset B = 19%

Standard deviation of asset A = 16%

Standard deviation of asset B = 34%

Covariance of asset A & B = 0.0064

Calculate expected return, variance & standard deviation. (10 Marks)

Ans 2.

Introduction

In portfolio management, investors often combine multiple assets with the intention of improving returns while managing risk more efficiently. When an investor allocates funds across two assets, the expected return, variance, and standard deviation of the combined portfolio provide crucial insights into its risk–return profile. These measures help determine whether the investor is achieving diversification benefits and whether the overall risk aligns with their investment goals. In this scenario, the investor has allocated 60 percent of the funds to Asset A and 40 percent to Asset B. Understanding how these weights, along with the returns, volatilities, and covariance of the assets, contribute to the portfolio’s performance is essential for assessing

 

 

Q3(A). A wealth management firm serves a diverse clientele, ranging from risk-averse retirees to aggressive young professionals. The firm has traditionally relied on the Markowitz model for portfolio construction but has found it lacking in addressing systematic risk and the dynamic nature of market returns. The investment team is exploring ways to incorporate CAPM concepts, such as beta and the risk-return trade- off, to create a more adaptive and client-centric asset allocation model. Develop an innovative asset allocation model for a diversified portfolio that addresses the limitations of the Markowitz model by integrating CAPM concepts, particularly the use of beta and the risk-return trade-off. How would your model improve portfolio selection for investors with varying risk appetites? (5 Marks)

Ans 3a.

Introduction

A wealth management firm catering to investors with different risk preferences requires a dynamic approach to asset allocation. Traditional reliance on the Markowitz model has helped construct diversification-based portfolios but falls short in capturing systematic risk and the shifting nature of market dynamics. To enhance adaptability, the investment team seeks to integrate CAPM concepts such as beta and the risk–return trade-off. This integration can create a more flexible, client-centric framework that aligns portfolio choices with each investor’s risk

 

Q3(B). A portfolio manager is evaluating the performance of four actively managed funds (P, Q, R, S) relative to the market. The following data is available:

Fund	Average Return (%)	Standard Deviation (%)	Beta
P	18	15	1.1
Q	14	10	0.8
R	16	12	1.0
S	12	8	0.6

 

The risk-free rate is 7% and the market return is 15% with a standard deviation of 11%. For each fund, calculate the Sharpe ratio, Treynor ratio, and Jensen’s alpha. Then, rank the funds according to each measure and discuss which fund would be considered the best under each criterion, providing a reasoned conclusion. (5 Marks)

Ans 3b.

Introduction

Evaluating actively managed funds requires analyzing performance not just in terms of returns but also the risk undertaken to achieve them. Measures such as the Sharpe ratio, Treynor ratio, and Jensen’s alpha offer deeper insights by integrating total risk, systematic risk, and excess return over market expectations. By applying these measures to four funds—P, Q, R, and S—the portfolio manager can determine which fund delivers the most efficient performa