You are working towards creating a portfolio which can minimize your risks and maximize returns. You have included the following asset classes in your portfolio currently.

Asset Class

$5$ Year Return

Standard Deviation

Sensex

$15\%$

$17\%$

Govt Bonds

$4\%$

$0\%$

Corporate Bonds

$8\%$

$10\%$

You try to gather correlation data on the above investments and come up with the following information.

Correlation Matrix

Sensex

Portfolio of Corporate Bonds

Government Bonds

Sensex

$1$

Corporate Bonds

$0\mathrm{.}14$

$1$

Government Bonds

$-0\mathrm{.}03$

$-0\mathrm{.}01$

$1$

Your friend suggests that you substitute the corporate bonds with a portfolio of real estate stocks $.$He says that he has created a portfolio of real estate stocks which has given him a return of $13\%$ over the last $5$ years at a standard deviation of $9\%.$ He says that his portfolio of real estate stocks has a correlation of minus $0\mathrm{.}05(-0\mathrm{.}05)$ with the Sensex and a correlation of $0\mathrm{.}2$ with government bonds.

a$)$ Explain what would be the effect on your portfolio if you substitute the corporate bonds with the portfolio of real estate stocks suggested by your friend. Give two reasons to

explain any change you would expect. $($Note: You do not have to compute expected risk and return.$)$

b$)$ Your understanding of capital market theory causes you to doubt the validity of the data provided by your friend on his real estate portfolio. Justify your skepticism.

Your friend also suggests that you add shares of a fast growing FMCG company$-$FastFood Ltd in your portfolio. He says this company has generated a positive alpha this year $($based on capm$).$He says that such a company is bound to have high a PE Ratio which makes it a good buy.

c$)$ What is PE Ratio?

d$)$ Do you agree with your friend? Why$/$Why noQ$2$ SET $($A$)$

You are working towards creating a portfolio which can minimize your risks and maximize

returns. You have included the following asset classes in your portfolio currently.

You try to gather correlation data on the above investments and come up with the following

information.

Correlation Matrix

Your friend suggests that you substitute the corporate bonds with a portfolio of real estate stocks

$.$He says that he has created a portfolio of real estate stocks which has given him a retum of $13\%$

over the last $5$ years at a standard deviation of $9\%.$ He says that his portfolio of real estate stocks

has a correlation of minus $0\mathrm{.}05(-0\mathrm{.}05)$ with the Sensex and a correlation of $0\mathrm{.}2$ with government

bonds.

a$)$ Explain what would be the effect on your portfolio if you substitute the corporate bonds

with the portfolio of real estate stocks suggested by your friend. Give two reasons to