ECN604 Business Finance Workshop 1
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ECN604 Business Finance
Workshop 1
Q1:
Consider the probability distribution below. (Note that the expected returns of A and B have already been computed for you.)
State |
p(s) |
RA |
RB |
Recession Normal Boom |
0.3 0.4 0.3 |
-0.11 0.13 0.27 |
0.16 0.06 -0.04 |
Expected Return: 0.1 0.06 |
a. Calculate the standard deviations of A and B.
b. Calculate the covariance and correlation between A and B.
c. Calculate the expected return of the portfolio that invests 30% in stock A and the rest in stock B.
d. Calculate the standard deviation of the portfolio in part C.
Q2:
You have the following information on the returns of the ordinary shares
of Super Lux plc and the returns for the market.
Time |
Return of Super Lux |
Return of the market |
Year 1 |
18% |
10% |
Year 2 |
21% |
11% |
Year 3 |
20% |
8% |
Year 4 |
25% |
12% |
Year 5 |
26% |
14% |
Given that the yield on Treasury Bills is 8% and that the correlation coefficient between the returns on the shares of Super Lux plc and the returns on market is +0.83, calculate the rate of return on Super Lux's shares predicted by the CAPM.
Q3:
Mr Windle bought shares in Tate plc at the start of the year for £3.58. The year-end share price was £3.98 and he received a dividend per share of 10p. Tate plc has a beta of 1.27, the equity risk premium is estimated to be 5% and the risk-free rate of return is 5%. By how much has his investment under-/over-performed?
Q4:
True/false True or false? Explain or qualify as necessary.
a. Investors demand higher expected rates of return on stocks with higher overall risk.
b. The CAPM predicts that a security with a beta of 0 will offer a zero expected return.
c. An investor who puts $10,000 in Treasury bills and $20,000 in the market portfolio will have a beta of 2.0.
d. Investors demand higher expected rates of return from stocks with returns that are highly exposed to macroeconomic risks.
e. Investors demand higher expected rates of return from stocks with returns that are very sensitive to fluctuations in the stock market.
Q5:
Explain the difference between the effective annual rate (EAR) and the quoted rate. Of the two, which one has the greater importance, and why?
Q6:
Distinguish between an efficient portfolio and an optimal portfolio.
2023-03-23