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Topic covered: Risk and return
Risk and return move side by side and ignoring any one of these two for investment
decision can result in the irrational decision. Rational decision making requires investors
to analyze the company’s specific risk contribution of investment along with market
dynamics. Company-specific risk analysis helps investors to control the unsystematic risk
and to come up with a best possible portfolio (a combination of highest return and lowest
risk). Market dynamics can over-price or underprice a stock that can be a trap for the
investors; Capital Asset Pricing Model (CAPM), Security Market Line (SML) and
Gordon’s Formula can help investors to take a rational decision by calculating fair
pricing of the stocks. Unlike market risk; investors can control the company’s specific
risk if they have calculated the fair price and required rate of return of the available
investment options correctly.
Suppose you have to construct a portfolio for which you have considered three different
sectors (Textile, Chemical and Food). Stock L and K from Chemical and Food sector
have already been selected while one stock is required from the Textile sector to
construct the portfolio. Further, information of three Stocks from the textile sector has
been provided below, and you need to select only one that can be added to your portfolio.

Sectors Stock Beta Required
Market price Dividend
(current year)
Textile Sector A 1.5 25,000 Rs. 35 Rs. 5 that grows
at constant rate of
B 1 25,000 Rs. 29 Rs. 6 that grows
at constant rate of
C 2 25,000 Rs. 40 Rs.10 that grows
at a constant rate
of 5%
Chemical sector L 1.5 30,000 Rs. 42 NA
Food sector K 1.0 45,000 Rs. 15 NA

Note: Risk-free rate is 15%, and market return is 25%
Question #01.
Calculate the Fair price of each stock for the Textile sector (9 marks).

Question #02.
Based on fair price calculation of the Textile sector’s stocks in Question #01; categorize each stock either undervalued or overvalued (also provide reasoning that why a stock is overvalued or undervalued) (4 marks).

Stocks Overvalued or Undervalued Reason
Stock A ? ?
Stock B ? ?
Stock C ? ?

Question #03.Complete your investment portfolio by the decision in Question #2 (1
Investment Portfolio

Sector Stock Required Investment
Textile Sector ? ?
Chemical Sector L 30,000
Food Sector K 45,000

Question #04.Based on the answer to Question #03; calculate the beta of your portfolio (2 marks).

Question #05.
Calculate required rate of return of stocks in the Textile sector if the risk free rate of return decreases to 10% (keeping all other things same), which stock will have a highest required rate of return?(4 marks).

Formula and complete working of each part is mandatory; marks will be deducted
in case of incomplete calculations

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Replies to This Discussion

Kindly share solution idea

total things that have to finds are 

1. instrinsic or fair price 

2. formula of under valued or over valued 

3. project beta 

4. required rate of return

i find just definition not formulas 

and i upload definition file in few hours 

plzzz everyone discuss more or that topic to find formula for the solution of the assignment 

fair value ans will tell us the under valued or overvalued figure

P* = DIV1/[rRF+(rM- rRF)A)-g

Here DIV = RS 5 for stock A

Risk Free Rate = 15%

Market Rate = 25%

Growth Rate of Dividend Constant = 10%

Beta of Stock A = 1.5

now calculate all the other values'

same for stock b and c, only change the value of stock same formula

Kindly give Suggestion & Solution

Any idea pls? Kindly post your opinion.

Any one can share Suggestion, Idea or Solution. Kindly share Hurry

solution plz

For question #1 the fair price of the stock can be calculated by the formula of Gordon's SML and the formula is
Po* = DIV1 / [ (rRF + (rM - rRF ) A ) - g]

complete Solution


ya correct ha ?

question ko kuch to hl krna shro kre aj extended day ha.


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