case study by calculation and
justifacton

Mr. Pawan Garg, a wealthy landlord has
approached you for professional advice on investment. He has a
surplus of Rs. 50 lakhs which he wishes to invest in share market
in the name of his wife on their marriage anniversary falling due
the next week. His wife is a senior employee in ONGD, a reputed
public sector oil exploration company. In the course of your
discussions, you find that he is a first timer to the secondary
market and by nature much risk averse. He also tells you that he
had wondered if investing in ONGD itself could be a good idea as it
is quite profitable and is owned by our good old government.
Besides, his wife would have reasons to know well in advance of any
possible disasters for the company, being their employee for nearly
two decades, also, she could justifiably be proud of owning such a
stake in her company.

While you agree with him on the choice of ONGD, you suggest that
by way of risk reduction, it would be prudent to invest part of the
money in BPDL, an equally reputed oil marketing company, also state
owned. At the end of the discussion, before committing the funds
for the next one year, Mr. Garg desires to know from you specific

1. What would be the likely return and risk if he invests
equal amounts in each of the two stocks?

You have the following historical data at your disposal which
you intend to use for analyzing the pattern of co-movement between
the stocks:

 Periods (years preceding the current one) 1 2 3 4 5 6 7 8 9 10 Returns (in %) ONGD (Ro) 30 15 20 -6 -4 10 10 25 -6 -2 BPDL (RB) 15 4 -3 10 25 10 6 -12 28 20

The current market price of a share of ONGD is Rs. 320 and that
of BPDL is Rs. 650. You are able to obtain the following forecast
from a reputed firm of portfolio managers on the future returns on
the two stocks over the next one year:

 State of the Economy Probability Return (in %) on ONGD BPDL Recession 0.3 -6 -2 Normal 0.4 9 15 Boom 0.3 30 20

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