Exam Paper

Section A

Answer FOUR questions from Section A

Each question carries 15 marks.

1. You are given the following data:

E(RA) = 0.04 var(RA) = 0.0025 cov(RA, RB) = 0.001 E(RB) = 0.08 var(RB) = 0.0049

(a) For an equally weighted portfolio (with portfolio weights xA=0.5 and xB=0.5) comprising securities A and B, calculate the following:

(i) The expected return on the portfolio, E(RP), (ii) The standard deviation of the return on the portfolio, ((RP). (5 marks)

(b) Calculate the portfolio weights that are associated with the minimum variance portfolio. (5 marks) (c) What are E(RP), var(RP) and ((RP) for the minimum variance portfolio? (5 marks)

2. (a) With reference to the Capital Asset Pricing Model (CAPM) with a risk-free asset, explain what is meant by the following:

(i) Capital market line, (ii) Security market line, (iii) Characteristic line. (9 marks)

(b) Suppose the relevant equilibrium model is the CAPM with unlimited borrowing and lending at the risk-free rate.

Given RF = 0.04 and E(RM) = 0.10, complete the blanks in the following table:

Stock E(Ri) (i

1 - 0.4 2 0.088 - (6 marks)

3. (a) With reference to the Capital Asset Pricing Model (CAPM), explain what is meant by the following statement:

“The total variance in the return on any security can be partitioned into two components, representing systematic risk and unsystematic risk”.

(6 marks) (b) Refer to the following data:

Stock i ((Ri, RM) var(Ri)

A 0.3 0.04 B 0.15 0.09

E(RM) = 0.1 var(RM) = 0.02 RF = 0.05

Note: ((Ri, RM) denotes the correlation coefficient between Ri and RM; i.e. ((Ri, RM) =[pic]

Calculate beta ((i)