MEETING 1 – Oct 2020

MAF603

QUESTION 1

Noble Bhd has excess funds for the coming year and identified 2 investments that appear to be
feasible. Each project requires the same initial outlay. The data regarding the investments are
given below.

State of Probability Stock’s return

Economy Econ Bhd Save Bhd
Recession 0.3 -12% -10%
Normal 0.5 9% 12%
Boom 0.2 30% 25%

Required:

a) Calculate the expected return and standard deviation of each stock above.

b) If you could only invest in one stock, which stock would you choose?

c) Calculate the covariance and correlation between the two stocks; Econ Bhd and Save Bhd.

QUESTION 2

Consider the following information about two securities:

State of Economy Probability Return on security Return on security

Daisy Flora
Recession 0.2 10 10
Normal 0.5 15 20
Expansion 0.3 25 30

Required:

a) Determine the expected return and standard deviation of each security.

b) Which security would you invest in? Why?

QUESTION 3

Portfolio A Portfolio B
Security Expected Standard Weight Security Expected Standard Weight
return deviation % return deviation %
Econ 50 Econ 30
Bhd Bhd
Save 50 Save 70
Bhd Bhd

a) Calculate the expected return and standard deviation of the investment portfolio A and
portfolio B above.

b) Which of the above portfolios would be a better investment? Explain your recommendation.

QUESTION 4

Suppose you have invested RM100,000 in the following three (3) securities.

Security Amount invested Expected return Beta

(RM) (%)
Orchid 20,000 14 0.75
Lavender 30,000 13 1.10
Roses 50,000 25 1.88

Additional information:

The risk-free rate is 5 percent.

The expected market return on the market portfolio is 15 percent.

Required:

Assuming the CAPM holds.

a) Calculate the required return of each stock.

b) State whether each stock is correctly priced.

c) Which security would you recommend buying?

d) Calculate beta for the portfolio.

d) Construct the Security Market Line (SML) graph by indicating the position of stocks in the
diagram.
QUESTION 5

The following data is pertinent for two portfolios.

Portfolio Expected return Beta

A 0.8

B 1.84

Required:

Assume capital asset pricing model holds.

a) Calculate the required return for each of the portfolios above.

b) Evaluate whether the above portfolios are correctly priced. Explain your answer.

(Assume that the yield on Treasury bills is 5% and the market risk premium is 7%).

c) If you could invest in only one portfolio, which one would you choose? Briefly explain.