QUESTION 1 (a) In the context of the Capital Asset Price Model (CAPM): Explain the meaning of systematic risk and unsystematic risk Define the concept of Beta and outline how it is measured Define the term risk premium and explain how it can be calculated (i) (ii) (iii)
QUESTION 1 (a) In the context of the Capital Asset Price Model (CAPM): Explain the meaning of systematic risk and unsystematic risk Define the concept of Beta and outline how it is measured Define the term risk premium and explain how it can be calculated (i) (ii) (iii)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:QUESTION 1
(a)
In the context of the Capital Asset Price Model (CAPM):
Explain the meaning of systematic risk and unsystematic risk
Define the concept of Beta and outline how it is measured
Define the term risk premium and explain how it can be calculated
(i)
(ii)
(iii)
(b) Tinto Ltd wishes to invest in a project. The following is available:
Tinto
Project
Expected returns
Standard deviation of returns
Expected returns correlation with the market +0.3
10%
5%
Required:
Calculate:
16%
7%
(i) The beta for Tinto and the project.
(ii) Tinto's current cost of equity.
(iii) The return of Tinto after accepting the project.
(iv) The risk of Tinto after accepting the project.
(v) The project's required return based on the CAPM.
+0.6
The risk free rate is 6%. Correlation between Tinto and the project is +0.1. If the
project is accepted it will account for 10% of the value of Poly Corp Ltd.
Market
14%
4%
1
Transcribed Image Text:QUESTION 1
Mr. Donald has approached you for financial advice. He has identified two shares, one of Future Growth
Ltd (Share F) and another the equity share of Growbig Plc (Share G). He avails the following information
to you:
Namibian Economy
Depressed
Buoyant
Bullish
Probability
0.3
0.5
0.2
Expected Return
Share F
2%
10%
12%
Additional information:
1. The return on the Government of Namibia treasury bills is 3%.
2. The market return is 12%.
3. The standard deviation of the expected market return is 6%.
4. The covariance of Share F's returns with the market is 25.2
5. The covariance of Share G's returns with the market is 39.6
Required:
Expected Return
Share G
15%
22%
-2%
(a) Calculate the correlation coefficient of Share F and Share G.
(b) Form a portfolio of 40% Share F and 60% Share G. Using relevant calculations advise Mr. Donald
whether to invest in the portfolio or either Share F or G.
(c) Calculate the required return for shares F and G according to the Capital Asset Pricing Model
and discuss whether you would advise the investor to invest in either Share F or Share G.
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