NISM Series X-A: Investment Adviser (Level 1) Cert. 'Case Study 4'

Mr. Nitin’s investment portfolio, which includes both equity and debt in the ratio of 20:80, suggests a balanced approach, suitable for someone in the stage of life with family responsibilities. The negative correlation between debt and equity indicates a potential diversification benefit. The return expectation aligns with a balanced portfolio approach. The mention of school-going kids suggests family responsibilities, making option b) the most suitable description.

Liquid assets are those assets that can be easily converted into cash at short notice to meet expenses or emergencies. Liquid assets include money in savings bank account, fixed deposits that mature within 6 months, investment in short-term debt schemes of mutual funds and such other short-term assets.

Some assets may be easily converted into cash but their values may fluctuate widely in the short-term, thus making them unsuitable for realising cash at short notice. Shares and open-end equity schemes fall under this category. Open-end debt schemes too have a significant market element in their valuation which makes their return volatile, and therefore unsuitable to meet the need for funds at short notice.

In the above example the following are liquid assets :

Short Term Bank Fixed Deposits – Rs 2 lacs

Liquid Schemes – Rs 5 lacs

Saving Bank a/c Rs 1 lac.

Networth = Assets – Liabilities

As calculated in the previous sum, His assets are valued at Rs 89 lakhs and Liabilities at Rs 22 lacs

So his Networth is 89 – 22

= Rs 67 lacs.

Solvency Ratio = Networth / Total Assets

= 67 / 89

= .75

= 75%

(Higher the solvency ratio, stronger the investor’s financial position)

Leverage Ratio = Total Liabilities / Total Assets.

Total Liabilities = Rs 22 lacs

Total Assets = 89 lacs ( take house at current valuation )

Leverage ratio = 22 / 89

= 24.72%

The formula for calculating returns is : (WE x RE) + (WD x RD)

WE – Weight of Equity = 0.25

RE – Return on Equity = 14

WD – Weight of Debt = 0.75

RD – Return of Debt = 8

= (0.25 x 14) + (0.75 x 8)

= 3.5 + 6

= 9.5%

The variables that affect the portfolio risk are:

1. Weights of investments: The allocation or proportion of the portfolio invested in each asset class (Equity or Debt).
2. Risk of investments: The standard deviation or volatility of the returns of each individual investment (Equity or Debt).
3. Co-movement between investments: The correlation or relationship between the returns of different investments in the portfolio.

The formula for Weighted Standard Deviation is :

SQUARE ROOT of ⟶ WE² (ie Weight of Equity square) x Std Dev E² (ie. Std Dev of Equity square) + WD² (ie. Weight of Debt square) x Std Dev D² (ie. Std Dev of Debt square) + 2 x WE x WD x Corelation x Std Dev E x Std Dev D

Substituting the values :

= (0.75² x 9²) + (0.25² x 4²) + (2 x 0.25 x 0.75 x (-0.4) x 9 x 4)

= 0.00455625+0.0001-0.00054

=0.00411625

=41.16%

Square Root of 41.16 = 6.41%