(a)Discuss five elements of investmentpol icy statement (I PS).(5 marks)

(b)With reference to Markowitz portfolio theory, examine three problems associated with instabilityoftheminimum variance frontier.(3 marks)

(c)You have been appointedas aportfoliomanagerof a big fund.After evaluatingthe investmentportfolioof the fund, you divide the market into four portfolios following two dimensions:Val ue/GrowthandSmall/Large.The weightofeach portfolio in the index is given below. You designed the following model:

Portfolio

Small val ue Small growth Large val ue Lars e growth Risk premi url

The risk free rate is 2%.

Weight

(%)

5

5

40

50

Sensitivity toSensitivity toSensitivity to facto r 1 factor 2facto r 3

(Market beta)(Price/Book)(Average ca pitulisation)

0.850.801

0.950.301

0.9028

1.10310

8%-2%0.10%

Required:

(i)Using the arbitrage pricing theory (A PT), determine the portfolio that has the highest expected return. (4 marks)

(ii)One of your competitors uses the capital asset pricing model (CAPM)to calculate the expectedreturn.Based on the betas illustrated above, determine the portfolio that he shout d choose in order to maximise his expected

return.Summit Bank Limited (SB L) is a commercial bank with operations in East Africa.

Required:

Evaluate the effect of each of the following scenarios on SBL's investment objectives, constraints, or risk taking ability:

(i)The tarset averagematurity of loans is increased,with overallrisk tolerance unchanged.(1 mark)

(ii)The Asset Liability Committee (ALCO) decides to increase SB L's credit standards for loans although the bank's overallrisk tolerance is unchanged.( I mark)

(iii)More opportunities exist for expanding net interest margins with low risk in SB L's loan portfolio in its securities portfolio.( 1 mark)

(e)Jack line Mora a is a portfolio manager in a leading investment fi rm. She is interested inusing ValueatRisk (VaR) modelto monitorrisk exposure of her employer'sgovernmentbondportfol io.The currentinformationrelatin e to the

sovernment bond portfolio is shown below:

Port fol io valueSh. 1,400 mill ion

Expectedannualisedrate of return6%

Standard deviationof annualisedrate of return7%

Note:The standard normal distribution Z-values for the 0.05 and 0.01 probability levels are 1.65 and 2.33 respectively.

Required:

The 1 % monthl y Val ue at Risk (Va R), in shillings, for the government bond portfolio.

(4 marks)An error is an irregularity in the accounting records that renders the financial statements not valid.

The trial balance of Pepe Enterprise as at 31st March, 2012 had an unidentified error hence the Trial Balance was not balanced. The Trial Balance was balanced by inclusion of a debit balance difference of KES 5,000 passed to a suspense account.

Further investigations revealed the following errors:

(1) The total sales day book for March 2012 had been overstated by KES 4,500.

(2) Discount received of KES 2,500 in January 2012 had been posted to the debit of the discount allowed account.

(3) Payment by cheque to a creditor for KES 3,150 had been entered in the cash book as

KES 1,350.

(4) Wages of KES 4,200 paid in the month of March had not been posted from the cash book.

(5) In March 2012, purchases of new equipment amounting to KES 10,000 had been debited to the purchases account.

2

(6) A remittance of KES 2,700 received from a credit customer in March 2012, had been credited to the sales account.

(7) The proprietor of Yepe Enterprise withdrew a cheque of KES 1,400 for his personal use.

The bank account and the drawings account were both credited.

Required:

Pass journal entries to correct each of the errors discovered and ensure the suspense account balance is cleared to zero.

Note: No narration is required.