a). Gold Coast Securities Ltd is considering two investment opportunities, purchasing stocks or corporate bond. Consider the following information on the two investments: Probability Return on Stocks (%) Return on Bonds (%) 0.3 30 5 0.4 25 15 0.2 20 28 0.1 10 35 Required: a). Compute the following: i). Expected return of the two investments. ii).The standard deviation of the two investments. b). In order to minimize its exposure, Java Ltd has been thinking about diversifying along two options shown below: i). Portfolio I: invest 40,000 cedis in shares and 60,000 cedis in bonds. ii). Portfolio II: invest 55,000 cedis in shares and 45,000 cedis in bonds. Compute the expected return and standard deviation of each portfolio if the correlation coefficient of the return of the two investments is -0.35. c). Which portfolio would you recommend to Gold Coast based on risk and returns?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
a). Gold Coast Securities Ltd is considering two investment opportunities, purchasing stocks or corporate bond. Consider the following information on the two investments:
| Probability | Return on Stocks (%) | Return on Bonds (%) |
| 0.3 | 30 | 5 |
| 0.4 | 25 | 15 |
| 0.2 | 20 | 28 |
| 0.1 | 10 | 35 |
Required:
a). Compute the following:
i). Expected return of the two investments.
ii).The standard deviation of the two investments.
b). In order to minimize its exposure, Java Ltd has been thinking about diversifying along two options shown below:
i). Portfolio I: invest 40,000 cedis in shares and 60,000 cedis in bonds.
ii). Portfolio II: invest 55,000 cedis in shares and 45,000 cedis in bonds.
Compute the expected return and standard deviation of each portfolio if the correlation coefficient of the return of the two investments is -0.35.
c). Which portfolio would you recommend to Gold Coast based on risk and returns?
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 8 images
