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Risk and Return/CME & AA

Formula
1. Probability and Ratio / Return দেওয়া থাকলে।
Expected Returns: -
(i) E(R) = ∑ 𝑅𝑖 𝑃𝑖 [with Probability]
= R1 × P1 + R2 × P2 + R3 × P3
∑𝑅
(ii) E(R) = 𝑁𝑖 [without Probability]
2. Table for calculation of variance and standard deviation: -
(i) σ = √∑[𝑅𝑖 − 𝐸(𝑅)]2 × 𝑃𝑖 [with Probability]
∑[𝑅𝑖 −𝐸(𝑅)]2
(ii) σ = √ [without Probability]
𝑁
* Variance: (i) σ2 = ∑ [Ri – E(R)]2 × Pi [with Probability]

3. Covariance: (i) COVAB =∑[𝑹𝒊 − 𝑬(𝑹)]𝟐 𝒙 × ∑[𝑹𝒊 − 𝑬(𝑹)]𝟐 𝒚 × 𝑷𝒊 [with Probability]

∑[𝑹𝒊 −𝑬(𝑹)]𝟐 ∑[𝑹𝒊 −𝑬(𝑹)]𝟐

4. (ii) COVAB = * [without Probability
𝑵 𝑵
𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒
5. Correlation (r) = 𝜎𝐴 × 𝜎𝐵
𝜎𝑖
6. Co-efficient of variance (C.V) = 𝐸(𝑅)𝑖 × 100
Notes for C.V = ২ টি stock এ Expected return সমান হলে শুধু Standard deviation দের কলর Decision ননলে হলে নকন্তু Expected
return অসমান হলে C.V দের কলর Decision ননে
σ / C.V কম হলে ঝনুঁ ক কম হয়
σ / C.V দেনি হলে ঝনুঁ ক দেনি হয়
*** আমরা সে েব া কম ঝনুঁ ক সম্পন্ন Calculation Accept করলো।
If investment at the beginning and end of the year and cash flow or dividend for the whole year is given:
𝐷/𝐶𝐹/𝐼 + (𝑃𝐸 − 𝑃𝐵 )
7. Total Return (TR) = × 100
𝑃 𝐵

8. Relative Returns (RR) = 1 + TR

Portfolio
9. Portfolio Expected Return E(RP) = ∑Wi*E( R )
= WA × E(RA) + WB × E(RB) + WC × E(RC)
10. Portfolio Standard deviation for two securities A and B
σP = √(WA σA )2 + (WB σB )2 + 2 . WA . WB . COVAB
Or,
σP = √(WA σA )2 + (WB σB )2 + 2 . WA . WB . 𝜎𝐴 . 𝜎𝐵 rAB

For securities A, B and C

σP = √(WA σA )2 + (WB σB )2 + (WC σC )2 + 2 . WA . WB . COVAB + 2 . WB . WC . COVBC + 2 . WC . WA . COVCA
Or,
σP= √(WA σA )2 + (WB σB )2 + (WC σC )2 + 2 . WA . WB . 𝜎𝐴 . 𝜎𝐵 rAB + 2 . WB . WC . 𝜎𝐵 . 𝜎𝐶 rBC + 2 . WC . WA . 𝜎𝐶 . 𝜎𝐴 rCA
Notes: -
যনে অংলক এর r মান দেওয়া থালক েলে Portfolio Standard deviation ননর্ য়ব করলে or (অথো) সূত্র ব্যেহার করলো।

𝐼𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 1
11. Weight (Wi) = / 𝑁𝑜. [Equal Weight েেলে]
𝑇𝑜𝑡𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑆𝑒𝑐𝑢𝑟𝑖𝑡𝑦

Problem – 01 [DU. BBA - 2014]

Return of two securities for last five years are as follows:
Year 1 2 3 4 5
Stock A 8% 3% 16% – 2% 10%
Stock B 4% 5% 10% – 2% 8%
Calculate: Expected rate of return. E(R).

Solution
Tips & Help Line: ** প্রশ্নপলত্র Number of years থাকাই েছলরর সংখ্যা দ্বারা ভাগ করা হল়েলছ।
Calculation of Expected rate of retune (R):
∑ 𝑅𝑖
We know that, E(R) =
𝑁
∑ 𝑅𝑖
For-A: E(RA) =
𝑁
𝑅1 + 𝑅2 + 𝑅3 + 𝑅4 + 𝑅5
=
𝑁
8% + 3% + 10% + (−2%) + 10%
=
5
35
= = 7% Ans.
5
For-B: E(RB)
4% + 5% + 10% + (−2%) + 8%
=
5
25
= = 5% Ans.
5

Problem – 02 [DU. MBA - 2013]

Stock X and Y have the following probability distribution of expected future returns:
Probability Stock X Stock Y
0.1 – 10% – 35%
0.2 2% 0%
0.4 12% 20%
0.2 20% 25%
0.1 38% 45%
Required: Calculate the Expected rate of return E(R) for each stock.
Solution
Tips & Help Line: ** প্রশ্নপলত্র Probability আলছ নেধা়ে Probability দ্বারা গুর্ করা হল়েলছ।
Calculate the expected rate of return E(R):
We know that, E(R) = ∑ 𝑅𝑖 𝑃𝑖
For Stock-X: = (R1 × P1) + (R2 × P2) + (R3 × P3) + (R4 × P4) + (R5 × P5)
= (– 10% × .10) + (2% × .20) + (12% × .40) + (20% × .20) + (38% × .10)
= – 1% + .40% + 4.80% + 4% + 3.80%
 = 12% Ans.
For Stock-X: = (R1 × P1) + (R2 × P2) + (R3 × P3) + (R4 × P4) + (R5 × P5)
= (– 35% × .10) + (0% × .20) + (20% × .40) + (25% × .20) + (45% × .10)
= – 3.50% + 0% + 8% + 5% + 4.50%
= 14% Ans.
Problem – 03 [BU. BBA - 2014]
A company is considering project X with the following information:
Probability (P) 10 20 10 20 10
Return (R) 40% 10% 0% 5% 15%
Calculate the standard deviation, when expected value of return for the project is 8.50%.

Solution
Tips & Help Line: ** প্রশ্নপলত্র দযলহতু Probability দেও়ো আলছ দসলহতু Probability এর সাহালে Standard Deviation ননর্ ়েব করলে
হলে।
Calculation of Standard deviation (SD) / σ:
We Know that, σi = √∑[𝑅𝑖 − 𝐸(𝑅)]2 × 𝑃𝑖

σx = √(40% − 8.50%)2 × .10 + (10% − 8.50%)2 × .20 + (0% − 8.50%)2 × .10 + (5% − 8.50%)2 × .20 + (15% − 8.50%)2 × .10

= √(31.50%)2 × .10 + (1.50%)2 × .20 + (−8.50%)2 × .10 + (−3.50%)2 × .20 + (6.50%)2 × .10

= √99.225% + 0.45% + 7.225% + 2.45% + 4.225%

= √113.575%

= 10.66%

Problem – 04
The Akthar furniture and Brother furniture Company have the following joint Probability distribution of return for the next
year
State of Economy Akthar Furniture Brother Furniture Probability
Return (%) Return (%)
Boom 12 16 0.40
Recession 10 –5 0.30
Normal 11 14 0.30
(a) Calculate the expected co-variance of returns for the Akthar furniture and Brother furniture company.
(b) What is the correlation of returns between the Akthar and Brother furniture company?

Solution:
(a) To determine co-variance, at first we have to calculate Expected Return for each Company.
Let, Akthar furniture = A
Brother furniture = B
𝑛

. ᱸ. E(R) = ∑ 𝑅𝑖 𝑃𝑖
𝑖=1
E(RA) = (0.12 × 0.40) + (0.10 × 0.30) + (0.11 × 0.30)
= 0.048 + 0.03 + 0.033
= 0.111 = 11.1%
E(RB) = (0.16 × 0.40) + (– 0.05 × 0.30) + (0.14 × 0.30)
= 0.064 + (– 0.015) + 0.042
 = 0.091 = 9.1%
We know,
n

Co − variance, CovAB = ∑[{R A − E(R Ai )} {R Bi − E(R B )}] Pi

i=1
.ᱸ. CorAB = [(0.12 – 0.111) (0.16 – 0.091)]0.04 + [(0.10 – 0.111) (– 0.05 – 0.091)] 0.03 + [(0.11 – 0.111)
(0.14 – 0.091)] 0.30
= 0.00002484 + 0.00004653 -0.0000147
= 0.000699
(b)
We know,
CovAB
Correlation Co-efficient, CorAB =
σA σB
Workings,
.ᱸ. σA = √∑{R A − E(R A )}2 Pi
= √(0.12 − 0.111)2 0.40 + (0.10 − 0.111)2 0.30 + (0.11 − 0.111)2 0.30
= √0.0000324 + 0,0000363 + 0.0000003
= √0.000069
= 0.008306
.ᱸ. σB = √(0.16 − 0.091)2 0.40 + (− .05 − 0.091)2 0.30 + (0.14 − 0.091)2 0.30
= √0.0019044 + 0.0059643 + 0.0007203
= √0.0085890
= 0.092676857
.ᱸ. Correlation Co-efficient, CorAB
CovAB
=
σ A σB
0.000699
=
0.008306 × 0.092676857
0.000699
=
0.000769773
= 0.9080

Problem – 05
The following information are available for stock X, Y and Z.
Stock Bear Market Normal Market Bull Market
Stock – X 15% – 12% 16%
Stock – Y 20% – 8% 25%
Stock – Z 25% 10% – 10%
Probability 0.4 0.3 0.3
Required:
(a) Calculate the expected rate of return for each stock.
(b) Calculate the standard deviation for returns on stocks X, Y and Z.
(c) Assume you invest your Tk. 50,000 portfolios into a Tk. 10,000 in stock 'X' and rest of them equally invest in stock Y
and Z. What is the expected return on your portfolio?

Solution:
(a) We know, Expected Rate of Return,
𝑛

. ᱸ. E(R) = ∑ 𝑅𝑖 𝑃𝑖
𝑖=1
For stock 'X'
E (RX) = (15 × 0.4) + (– 12 × 0.3) + (16 × 0.3)
= 6 + (– 3.6) + 4.8
= 7.2%
For stock 'Y'
E (RY) = (20 × 0.4) + (– 8 × 0.3) + (25 × 0.3)
= 8 + (– 2.4) + 7.5
= 13.1%
For stock 'Z'
E (RZ) = (25 × 0.4) + (10 × 0.3) + (– 10 × 0.3)
= 10 + 3 – 3
= 10%
(b) Standard Deviation for each stock:
We know,
𝑛

𝑆𝐷, 𝜎 = √∑[(R i − E(R)]2

𝑖=1

σX = √0.04 [15 − 7.2]2 + 0.3 [− 12 − 7.2]2 + 0.03 [16 − 7.2]2

= √24.336 + 110.592 + 23.232
= √158.16
= 12.57%
σY = √0.04 [20 − 13.1]2 + 0.3 [− 8 − 13.1]2 + 0.03 [25 − 13.1]2
= √19.044 + 133.563 + 42.483
= √195.09
= 13.96%
σZ = √0.04 [25 − 10]2 + 0.3 [10 − 10]2 + 0.03 [− 10 − 10]2 𝑰𝒏𝒅𝒊𝒗𝒊𝒅𝒖𝒂𝒍 𝑽𝒂𝒍𝒖𝒆
Wi =
= √90 + 0 + 120 𝑻𝒐𝒕𝒂𝒍 𝑽𝒂𝒍𝒖𝒆

= √210 𝟏𝟎,𝟎𝟎𝟎
= 14.49% Wx= 𝟓𝟎,𝟎𝟎𝟎 = .20
(c) Expected Portfolio Return:
We know, E (RP) =∑Wi*E( R ) 𝟐𝟎,𝟎𝟎𝟎
Wy= 𝟓𝟎,𝟎𝟎𝟎 = .40
= E(RX) WX + E(RY) WY + E(RZ) WZ
= (7.2 × 0.20) + (13.1 × 0.40) + (10 × 0.40)
= 1.44 + 5.24 + 4 𝟐𝟎,𝟎𝟎𝟎
Wz= 𝟓𝟎,𝟎𝟎𝟎 = .40
= 10.68%

Problem – 06 [NU. BBA (Hon's) - 2008]

Mr. Henry can invest in highball stock and Slow bear stock. His projection of the returns on these two stocks are as follows:
State of Economy Probability of state Occurring Return on Highball Stock (%) Return on Slow bear Stock (%)
Recession 0.25 – 2.00 5.00
Normal 0.60 9.20 6.20
Boom 0.15 15.40 7.40
a. Calculate the expected return on each stock.
b. Calculate the standard deviation of returns on each stock.
c. Calculate the covariance and correlation between the returns on the two stock.

Solution
Required-(a): Calculation of expected rate of return E(R):
For- (highball stock): E(R) = ∑ 𝑅𝑖 × 𝑃𝑖
 E(RA) = R 1 × P 1 + R2 × P 2 + R 3 × P 3
= – 2% × .25 + 9.20% × .60 + 15.40% × .15
= – .50% + 5.52% + 2.31%
= 7.33%
For- (Slow bear stock):
E(RA) = R1 × P1 + R2 × P2 + R3 × P3
= 5% × .25 + 6.20% × .60 + 7.40% × .15
= 1.25% + 3.72% + 1.11%
= 6.08%
Required-(b): Calculation of Standard deviation (SD) / σ
For- (highball stock):
We Know that, σ = √∑[𝑅𝑖 − 𝐸(𝑅)]2 × 𝑃𝑖
= √(−2% − 7.33%)2 × .25 + (9.20% − 7.33%)2 × .60 + (15.40% − 7.33%)2 × .15
= √(−9.33%)2 × .25 + (1.87%)2 × .60 + (8.07%)2 × .15
= √21.76% + 2.10% + 9.77%
= √33.63%
= 5.80%
For- (Slow bear stock):
We Know that, σ = √∑[𝑅𝑖 − 𝐸(𝑅)]2 × 𝑃𝑖
= √(5% − 6.08%)2 × .25 + (6.20% − 6.08%)2 × .60 + (7.40% − 6.08%)2 × .15
= √(−1.08%)2 × .25 + (0.12%)2 × .60 + (1.32%)2 × .15
= √0.2916% + 0.00864% + 0.26136%
= √0.5616%
= 0.75%
Calculate a table for Variance
Required - (c): Calculate of Covariance and correlation between the returns on the two stock.
We know that, Covariance =
=√(−2% − 7.33%)2 × .25 × (5% − 6.08%)2 × .25 + (9.20% − 7.33%)2 × .60 × (6.20% − 6.08%)2 × .60 + (15.40% − 7.33%)2 × .15 × (7.40% − 6.08%)2 × .15
= √(−9.33%)2 × .25 × (−1.08%)2 × .25 + (1.87%)2 × .60 × (0.12%)2 × .60 + (8.07%)2 × .15 × (1.32%)2 × .15
= √21.76% × 0.2916% + 2.098% × 0.00864% + 9.7687% × 0.26136%
= √8.916274152
= 2.986%
𝐶𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 2.986
Again, Correlation = = = 0.686 Ans.
𝜎𝐴 × 𝜎 𝑏 5.80 × 0.75

Problem – 07 [NU. (Hons) - 2016]

Stock A and Stock B have the following distribution of expected future returns:
Probability Stock A Stock B
0.10 – 10% – 35%
0.20 2% 0%
0.40 12% 20%
0.20 20% 25%
0.10 38% 45%
Calculate expected return, standard deviation(Risk) and co-efficient of variation. An investor seeks your opinion as to
which stock he should invest his money in . which stock would you recommend that the investor will buy ? Explain

Solution
Calculation of Expected Return:
We know that,
E(Ri) = ∑ 𝑅𝑖 𝑃𝑖
Now, E(RA) = – 10%* (0.1) + 2% (0.2) + 12% (.4) + 20% (0.2) + 38% (0.1)
= – 1% + 0.4% + 4.8% + 4% + 3.8%
= 12%
E(RB) = – 35 (0.1) + 0 (0.2) + 20 (0.4) + 25 (0.2) + 45 (0.1)
= – 3.5 + 0 + 8 + 5 + 4.5
= 14%
Calculation of Risk (Standard Deviation):
We know that,
σi = √∑[𝑅𝑖 − 𝐸(𝑅)]2 × 𝑃𝑖
Now,
1
σA=[(−10% − 12%)2 (0.1) + (2 − 12)2 (0.2) + (12 − 12)2 (0.4) + (20 − 12)2 (0.2) + (38 − 12)2 (0.1) ]2
1
= (48.4 % + 20 + 0 + 12.8 + 67.6)2
1
= (148.8)2
= 12.2%
Now,
1
σB = [(−35 − 14)2 (0.1) + (0 − 14)2 (0.2) + (20 − 14)2 (0.4) + (25 − 14)2 (0.2) + (45 − 14)2 (0.1) ]2
1
= (240.1 + 39.2 + 14.4 + 24.2 + 96.1)2
1
= (414)2
= 20.35%
Co-efficient of variation:
σA
CVA = × 100
E(RA )
0.122
= × 100
0.12
= 101.67
σB
CVB = × 100
E(RB )
0.2035
= × 100
0.14
= 145.36%

Comments : The investor should invest his

money in stock A & I would recommended him
stock A because its CV is lower than Stock B.
Problem – 08 [NU. - 2006]
Following are the information of two securities A and B for last four years –
Year Expected Return
A B
2002 40% 20%
2003 10% 10%
2004 10% 10%
2005 – 20% 00%
Mean (R) 10% 10%
Which security is more risky and why?

Solution
Now,
We know that,
∑[𝑅𝑖 −𝐸(𝑅)]2
σ=√
𝑁−1
Calculation of Standard Deviation (σ)
(40 − 10)2 + (10 − 10)2 + (10 − 10)2 + (− 20 − 10)2
σA =√
4−1
900 + 0 + 0 + 900
=√
3
1800
=√ 3
= √600
= 24.49%

(20 − 10)2 + (10 − 10)2 + (10 − 10)2 + (00 − 10)2

ΣB =√
4−1
100 + 0 + 0 + 100
=√ 3
200
=√ 3
= √66.67
= 8.16%
Comments : Security- A is more risky Because its SD is higher than Security - B.

Problem – 09
The following information is available for two stock P and Q.
Parr meter Stock - P Stock - Q
Expected Return E(R) 15% 16%
Standard Deviation σ 8% 10%
Correlation Co-Efficient .40.
(a) What is the Covariance between stock P and Q?
(b) What is the Expected Return and Risk of a Portfolio in which P and Q have weights of .70 and .30?

Solution
(a) We know,
 COV.PQ
Correlation Co-efficient, CorpQ =
σP σQ
COV.PQ
 0.40 =
(0.08) (0.10)
COV.PQ
 0.40 =
0.008
.˙. COVPQ = 0.0032

12. Portfolio Expected Return E(RP) = ∑Wi*E( R )

= WA × E(RA) + WB × E(RB) + WC × E(RC)
13. Portfolio Standard deviation for two securities A and B
σP = √(WA σA )2 + (WB σB )2 + 2 . WA . WB . COVAB (When given Covariance )
Or,
σP = √(WA σA )2 + (WB σB )2 + 2 . WA . WB . 𝜎𝐴 . 𝜎𝐵 rAB (When given Correlation)

(b) Expected Portfolio Return, E(RP) = ∑Wi E(R)i

.˙. E(R)p = (0.70 × 0.15) + (0.30 × 0.16)
= (0.105 + 0.048)
= 0.153
= 15.3%
Portfolio Risk,
2 2
𝜎𝑃 = √(WP )2 (σP )2 + (WQ ) (σQ ) + 2 . WP WQ σP σQ Cor.PQ
= √(0.70)2 (0.08)2 + (0.30)2 (0.10)2 + 2 × 0.70 × 0.30 × 0.08 × 0.10 × 0.40
= √(0.49 × 0.0064) + 0.0009 + 0.001344
= √0.00538
= 7.33%

Problem – 10 [NU. BBS (Hon's) - 2005]

Calculate the portfolio risk and return from the following information:
Year Return (%)
Stock - A Stock - B
2002 14 15
2003 12 17
2004 16 14
2005 18 19
Equally weighted portfolio is considered.

Solution
We know that, R+
∑ 𝑅𝑖
R==
𝑁
Here,
14 + 12 + 16 + 18
RA =
4
60
=
4
= 15%
 15 + 17 + 14 + 19
RA =
4
65
=
4
= 16.25%
Again, Calculation of SD
∑[𝑅𝑖 −𝐸(𝑅)]2
σ=√
𝑁−1
(14 − 15)2 + (12 − 15)2 + (16 − 15)2 + (18 − 15)2
σA =√
4−1
1+9+1+9
=√ 3
20
=√
3
= √6.67
= 2.58%
(15 − 16.25)2 + (17 − 16.25)2 + (14 − 16.25)2 + (19 − 16.25)2
ΣB =√
4−1
1.5625 + 0.5625 + 5.0625 + 7.5625
=√ 3
14.75
=√
3
= √4.92
= 2.22%
(14 – 15) (15 – 16.25) + (12 – 15) (17 – 16.25) + (16 – 15) (14 – 16.25) + (18 – 15) (19 – 16.25)
COV.A,B =
4
1.25 – 2.25 – 2.25 + 8.25 5
= => => 1.25
4 4
𝐶𝑂𝑉.𝐴,𝐵
Correlation ( r ) =
𝜎𝐴 𝜎𝐵
1.25
=
2.58 × 2.22
1.25
=
5.7276
= 0.22
Now, Portfolio Return,
E(Rp) = RA WA + RB WB
= 15 (0.5) + 16.25 (0.5)
= 7.5 + 8.125
= 15.625%
And, Portfolio Risk,
𝜎𝑃 = √(WA )2 (σA )2 + (WB )2 (σB )2 + 2 . WA WB σA σB r A,B
= √(2.58)2 (0.5)2 + (2.22)2 (0.5)2 + 2 × 2.58 × 2.22 × 0.5 × 0.5 × 0.22
= √1.6641 + 1.2321 + 0.630036
= √3.526236
= 1.88%

Problem –11 [NU. BBS (Hons) – 2009]

Return of two securities for last five years, are as follows:
Year 1 2 3 4 5
 Stock – A 8% 3% 16% – 2% 10%
Stock – B 4% 5% 10% – 2% 8%
Calculate:
(i) Covariance between securities A and B
(ii) Correlation between securities A and B.
(iii) Standard deviation and variance of two securities.
(iv) Portfolio return and portfolio standard deviation assuming:
(a) 50%, 50% Portfolio weight
(b) 70%, 30% Portfolio weight

Solution
Workings:
R1 + R2 + R3 + R4 + R5
E (RA) =
N
0.08 + 0.03 + 0.16 + (− 0.02) + 0.10
=
5
= 0.07 = 7%
R1 + R2 + R3 + R4 + R5
E (RB) =
N
0.04 + 0.05 + 0.10 + (− 0.02) + 0.08
=
5
= 0.05 = 5%
Req. – (i): Calculation of covariance:
Stock – A Stock – B [R – E (RA)] ×
R E (RA) [R – E (RA)] R E (RB) [R – E (RB)] [R – E (RB)]
0.08 0.07 0.01 0.04 0.05 – 0.01 – 0.0001
0.03 0.07 – 0.04 0.05 0.05 0 0
0.16 0.07 0.09 0.10 0.05 0.05 0.0045
– 0.02 0.07 – 0.09 – 0.20 0.05 – 0.07 0.0063
0.10 0.07 0.03 0.08 0.05 0.03 0.0009
∑ [R – E (RA)] × [R – E (RB)] = 0.0116

∑[R − E(RA )] × [R − E(RB )]

CovAB =
N
0.0116
=
5
= 0.00232
Req. – (ii):
CovAB
CorAB =
σA σB
0.00232
=
0.686 × 0.0458
0.00232
=
0.00314188
= 0.7384
Req. – (iii): Standard deviation:
[R1 − E(RA )]2 + [R2 − E(RA )]2 + [R3 − E(RA )]2 + [R4 − E(RA )]2 + [R5 − E(RA )]2
σA =√
N−1
(0.08 − 0.07)2 + (0.03 − 0.07)2 + (0.16 − 0.07)2 + (−0.02 − 0.07)2 + (0.10 − 0.07)2
=√
5−1
 0.0001 + 0.0016 + 0.0081 + 0.0081 + 0.0009
=√
4
0.0188
=√
4
= √0.0047
= 0.0686 = 6.86%
[R1 − E(RB )]2 + [R2 − E(RB )]2 + [R3 − E(RB )]2 + [R4 − E(RB )]2 + [R5 − E(RB )]2
σA =√
N−1
(0.04 − 0.05)2 + (0.05 − 0.05)2 + (0.10 − 0.05)2 + (−0.02 − 0.05)2 + (0.08 − 0.05)2
=√
5−1
0.0001 + 0 + 0.0025 + 0.0049 + 0.0009
=√
4
0.084
=√
4
= √0.0021
= 0.0458 = 4.58%
Variance:
Variance of A, σA 2 = (0.0686)2 = 0.0047 = 0.47%
Variance of B, σB 2 = (0.0458)2 = 0.0021 = 0.21%
Req. – (iv):
Portfolio Return:
(a): E (RP) = E (RA) × WA + E (RB) × WB
= (0.07 × 0.50) + (0.05 × 0.50)
= 0.035 + 0.025
= 0.06
= 6%
(b): E (RP) = E (RA) × WA + E (RB) × WB
= (0.07 × 0.70) + (0.05 × 0.30)
= 0.049 + 0.015
= 0.064
= 6%

Portfolio Standard:
(a): σP = √σA 2 WA 2 + σB 2 WB 2 + 2. WA WB COV
= √(0.0686)2 × (0.50)2 + (0.0458)2 × (0.50)2 + 2 × 0.50 × 0.50 × 0.00232
= √(0.00471 × 0.25) + (0.00209764 × 0.25) + 0.00116
= √0.0011775 + 0.00052441 + 0.00116
= √0.00286191
= 0.0535
= 5.35%
(a): σP = √σA 2 WA 2 + σB 2 WB 2 + 2. WA WB COV
= √(0.0686)2 × (0.70)2 + (0.0458)2 × (0.30)2 + 2 × 0.70 × 0.330 × 0.00232
= √(0.00471 × 0.49) + (0.00209764 × 0.09) + 0.0009744
 = √0.0023079 + 0.000188787 + 0.0009744
= √. 003471087
= 0.0589
= 5.89%

Problem – 12 [BU. BBA - 2015]

Four Securities have the following expected returns:
A = 12%, B = 20%, C = 15%, D = 10%
Calculate the expected return for a portfolio consisting of all four securities under the following condition:
(i) The portfolio weights are equal.
(ii) The portfolio weights are 10% in A. with the remainder equally divided among other three stocks.
(iii) The portfolio weights are 10% in each A and B with the remainder equally in each C and D.

Solution
Calculation of expected rate of return: E(R):
We know that, E(R) = ∑ 𝑅𝑖 𝑊𝑖
Required - (i):
1
Here: Wi = = 0.25 each
4
E(RP) = (RA × WA) + (RB × WB) + (RC × WC) + (RD × WD)
= (12% × .25) + (20% × .25) + (15% × .25) + (10% × .25)
= 3% + 5% + 3.75 % + 2.50%
= 14.25% Ans.
Required - (ii):
1 − .10 .90
Here: when , WA = .10 then , Wi = = = 0.30 each
3 3
E(RP) = (RA × WA) + (RB × WB) + (RC × WC) + (RD × WD)
= (12% × .10) + (20% × .30) + (15% × .30) + (10% × .30)
= 1.20% + 6% + 4.50 % + 3%
= 14.70% Ans.
Required - (iii):
1 − .20 .80
Here: when, WA = .10 WB = .10 then Wi = = = 0.40 each
2 2
E(RP) = (RA × WA) + (RB × WB) + (RC × WC) + (RD × WD)
= (12% × .10) + (20% × .10) + (15% × .40) + (10% × .40)
= 1.20% + 2% + 6 % + 4%
= 13.20% Ans.
Problem – 13
You are supplied the following information of Fahim Limited:
Stock E(R) Weight σ
A 0.12 0.40 0.06
B 0.18 0.60 0.12
Required:
(i) Return on portfolio;
(ii) Return on standard deviation.

Solution:
Req.-(ii): Return on portfolio (RP):
Here,
RA = 0.12 RB = 0.18 WA = 0.40 WB = 0.60 RP =?
RP = R A WA + R B WB
= (0.12 × 0.40) + (0.18 × 0.60)
= 0.048 + 0.108
= 0.156
or, RP = 15.6%
Req.-(ii): Return on standard devotion (𝛔𝐏 ):
Here,
σA = 0.06 σB = 0.12 WA = 0.40 WB = 0.60 σP =?

σP = √σA 2 WA 2 + σB 2 WB 2

= √(0.06)2 × (0.40)2 + (0.12)2 × (0.60)2

= √(0.0036 × 0.16) + (0.0144 × 0.36)
= √0.000576 + 0.005184
= √0.00576
= 0.0759
= 7.59%

Problem-14
ABC Company Ltd. Is considering two mutually exclusive projects X and Y . project X costs Tk. 3,60,000 and Project Y Tk.
3,60,000. You have been supplied with following NPV and probability distribution for each project:
Project-X Project-X
Estimated NPV Probability Estimated NPV Probability
Tk. 30,000 0.1 Tk.30,000 0.2
60,000 0.4 60,000 0.3
1,20,000 0.4 1,20,000 0.3
1,50,000 0.1 150,000 0.2

i) Compute the Expected NPV of projects X and Y.

E(NPV) = ∑ 𝑁𝑃𝑉𝑖 𝑃𝑖
= NPV1 × P1 + NPV2 × P2 + NPV3 × P3
=
ii) Compute the risk attached to each project that is standard deviation of each probability distribution.
σ = √∑[𝑁𝑃𝑉𝑖 − 𝐸(𝑁𝑃𝑉)]2 × 𝑃𝑖
=
iii) Which project do you consider more risky and why

Problem –15 [DU. MBA (Hon's) 2nd - 2005]

Determine the total return (TR) & Return Relative (RR), if a Bond, Stock and Warranty from the following information:
Bond Stock Warranty
Coupon Rate = 11% Dividend = Tk. 3 Cash = 10
Face Value = Tk. 1,000 Purchase Price = Tk. 32 Purchase Price = Tk. 220
Purchase Price = Tk. 950 Sales Price = Tk. 28 Sales Price = Tk. 280
Sales Price = Tk. 1,050 Time Period = 1 Year. Time Period = 1 Year.
Time Period = 1 Year No, of Shares = 100.

Solution
Required - (i): For Bond:
Here,
 FV = 1,000 I = (1,000 × 11%) = 110 P1 = 1,050 P0 = 950
𝐼/𝐷/𝐶𝐹 + (𝑃1 − 𝑃0 )
Calculation of total return: TR = × 100
𝑃0
110 + (1,050 − 950)
= × 100
950
110 + 100
= × 100
950
210
= × 100
950
= 22.11% Ans.
𝐼 + 𝑃1 110 + 1,050 1,160
Calculation of Return Relative: RR = = = = 1.221 Ans.
𝑃0 950 950
Required - (ii): For Stock:
Here,
P1 = 28 P0 = 32 D=3
𝐷 + (𝑃1 − 𝑃0 )
Calculation of total return: TR = × 100
𝑃0
3 + (28 − 32)
= × 100
32
3−4
= × 100
32
−1
= × 100
32
= – 3.125% Ans.
𝐷 + 𝑃1 3 + 28 31
Calculation of Return Relative : RR = = = = 0.969 Ans.
𝑃0 32 32
Required - (iii): For Warrant:
Here,
P1 = 280 P0 = 220 C = 10
𝐶𝑓 + (𝑃1 − 𝑃0 )
TR (Warrant) = × 100
𝑃0
10 + (280 − 220)
= × 100
220
10 + 60
= × 100
220
70
= × 100
220
= 31.82% Ans.
𝐶 + 𝑃1 10 + 280 290
Calculation of Return Relative : RR = = = = 1.32 Ans.
𝑃0 220 220

Problem – 16
Rathkhula Auto company has following dividend per share (D1) and market price per share (Po) for the period 2000 – 2005:
Year D1 (Tk.) Po (Tk.)
2000 2 30
2001 2 20
2002 2 30
2003 2.5 60
2004 2.5 100
2005 3 150
Calculate the annual rates of returns of Rathkhula Auto company's share for last five years. How risky is the shares?
Solution:
We know,
D1 + (P1 − Po )
Probable Return, P (R) = × 100
Po
Calculation of Return per year
𝐃𝟏 + (𝐏𝟏 − 𝐏𝐨 )
Year P1 (Tk.) Po (Tk.) (P1 – Po) D1 D1 + (P1 – Po) Return, P (R) = × 100
𝐏𝐨
−8
2001 20 30 – 10 2 –8 × 100 = – 26.67%
30
12
2002 30 20 10 2 12 × 100 = 60%
20
32.5
2003 60 30 30 2.5 32.5 × 100 = 108.33%
30
42.5
2004 100 60 40 2.5 42.5 × 100 = 70.83%
60
53
2005 150 100 50 3 53 × 100 = 53%
100
.ᱸ. Average Return,
– 2 6.67 + 60 + 108.33 + 70.83 + 53
E (R) =
5
265.49
= = 53.10%.
5
Now, Standard deviation,
2
∑(Ri − E(R))
σ =√
N−1
(− 26.67 − 53.10)2 + (60 − 53.10)2 + (108.33 − 53.10)2 + (70.83 − 53.10)2 + (53 − 53.10)2
=√
5−1
6,363 %+ 47.61 + 3,050 + 314 + 0.01
= √
4
9775%
=√
4
= √2444
= 49.43%
Comment: Since the value of standard deviation is high. It means that the share of Rathkhula Auto company is very
risky.

Problem – 17 [NU. BBS (Pass) – 2006]

Following are the price and other details of three stocks for the year 2005.
Compute the total return as well as return relatives for the three stocks.
Stock Beginning Price (PB) Dividend (D) Ending Price (PE)
A 30 3.40 34
B 72 4.70 69
C 140 4.80 146

Solution:
Calculation of Total Return (TR):
3.40 + (34 − 30)
TRA = × 100
30
 3.40 + 4
= × 100 = 24.67%
30
4.70 + (69 − 72)
TRB = × 100
72
4.70 − 3
= × 100 = 2.36%
72
4.80 + (146 − 140)
TRC = × 100
140
4.80 + 6
= × 100 = 7.71%
140
Calculation of Return Relatives (TR):
3.40 + 34 4.70 + 69 4.80 + 146
RRA = = 1.25 RRB = = 1.02 RRC = = 1.08
30 72 140

Problem –18 [NU. B. Com (Hon's) – 2004]

The data of a company are given below:
Probability Beginning Price (Tk.) Ending Price (Tk.) Dividend (Tk.)
25% 200 250 25
35% 200 280 25
18% 200 190 25
22% 200 160 25
Calculate return and risk from the above data.

Solution:
We know that,
Dt + (PE − PB )
TR = × 100
PB
Now,
25 + (250 − 200)
TR (25%) = × 100
200
25 + 50
= × 100 = 37.5%
200
25 + (280 − 200)
TR (35%) = × 100
200
25 + 80
= × 100 = 52.5%
200
25 + (190 − 200) 25 − 10
TR (18%) = × 100 => × 100 => 7.5%
200 200

25 + (160 − 200) 25 − 40
TR (22%) = × 100 => × 100 => – 7.5%
200 200
So,
E(R) = [37.5 (0.25) + 52.5 (0.35) + 7.5 (0.18) – 7.5 (0.22)]%
= 27.45%
Again,
Risk,
1
σ = [(37.5 − 27.45)2 (0.25) + (52.5 − 27.45)2 (0.35) + (7.5 − 27.45)2 (0.18) + (– 7.5 − 27.45)2 (0.22)]2
1
= [585.2475]2
= 24.19%
So, the return E (R) is 27.45% and risk σ is 24.19%
 CAPM = Capital Asset Pricing 0Model
Formula
1. Expected Return, E (R) :
E (R) = Rf + (Rm – Rf) 𝜷 [CAMP and 𝛽’s value will be given]

E(R) − Rf
2. Slope of SML =
β

Rm − Rf
3. Slope of CML =
σm

4. Determining Portfolio Expected Return using CML’s (or E(Rp)) slope :

Rm − Rf
E(Rp) = Rf + [ ] × 𝜎𝑝
σm

5. Beta, (𝛽) :
σi
i. 𝛽= × Ri,m [Correlation]
σm

COVi,m
ii. 𝛽= [Covariance]
σm

6. Weight, (Wi) :
Individual Value
i. Wi = [Unequal]
Total Value

1
ii. Wi = [Equal]
No. of Securities

7. Portfolio Beta, (βp ) :

β p = WA β A + W B β B + W C β C

8. Risk Premium, (Rm – Rf) :

E(RA )− E(RB )
R m – Rf =
βA − βB

9. Portfolio Expected Return, E(Rp) :

i. E(Rp) = WA E(RA) + WB E(RB) + WC E(RC) [Subject to Expected Return]

ii. E(Rp) = Rf + (Rm – Rf) βp [Subject to Portfolio Beta]

Problem – 19 (Given risk free & beta) [PU. BBA - 2014]

At present, suppose the risk free rate is 12% and the expected return on the market portfolio is 16%.
Find out the expected returns for four stocks with their expected beta:
Portfolios Beta
A 1.35
B 0.85
C 1.20
D 1.75
Solution
Tips & Help Line: ** প্রশ্নপলত্র Risk free and beta দেয়া আলছ নেধা়ে CAPM এর সূত্র ব্যেহার করা হল়েলছ।
Calculation of expected rate of return. E(R) Under CAPM.
Expected return, E(R) = Rf + β (RM – Rf)
A E(R) = 12% + 1.35 (16% – 12%) = 12% + 1.35 × 4% = 12% + 5.40% = 17.40%
B E(R) = 12% + 0.85 (16% – 12%) = 12% + 0.85 × 4% = 12% + 3.40% = 15.40%
C E(R) = 12% + 1.20 (16% – 12%) = 12% + 1.20 × 4% = 12% + 4.80% = 16.80%
D E(R) = 12% + 1.75 (16% – 12%) = 12% + 1.75 × 4% = 12% + 7% = 19%

Problem –20
Mr. Wahid owns a diversified portfolio security, which he estimates to have a standard deviation of 0.37. The return on
short-term T-Bills is 0.09 and he estimates the expected market return to be 0.14 and the market standard deviation to
be 0.28.
What is the expected return on the Wahid's portfolio according to CML?

Solution:
Here,
R f = Risk-free rate of return = T-bills return = 0.09 Rm = Expected market return = 0.14.
σm = Market standard deviation = 0.28 σP = Portfolio standard deviations = 0.37
According to CML,
Rm − Rf
E(R P ) = Rf + ( σm
) σP
0.14 − 0.09
= 0.09 + ( 0.28 ) 0.37
= 0.09 + 0.066
= 0.156 = 15.6%
Problem –21
An investor is seeking an efficient portfolio with a correlation of 0.7 between the portfolio and the market and a standard
deviation of 2.5%. The market standard deviation is 1.4% and the market rate of return is 16%, a rate that is double the
return on risk-free securities.
What is the required rate of return being sought by the investor?

Solution:
We know that,
E(R P ) = R f + (R m – R f ) βP
ρp.m × σp
= R f + (R m – R f )( )
σm
0.7 × 2.5
= 8 + (16 – 8) ( 1.4 )
= 8 + 8 × 1.25 = 18%
Problem –22
Data available for five stocks are as below –
Stock Beta Ri (%)
1 0.9 12
2 1.3 13
3 0.5 11
4 1.1 12.5
5 1.0 12
Assume that, the expected return for the market is 12% and the expected risk-free rate is 8%.
a) Calculate the expected return for each stock.
b) With these expected returns and betas, think of a line connecting them - what is this line?
c) Assume that an investor, using fundamental analysis, develops the estimates labeled Ri for these stocks. Determine
which are undervalued and which are overvalued.
d) What is the market's risk premium?

Solution:
(a) Given, R f = 8% and R m = 12%
So, R m – R f = 12% – 8% = 4%
We know that,
E(R) = R f + β (R m – R f ) [According to CAPM]
Now, E(R1) = 8% + 0.9 (4%)
= 11.6%
E(R2) = 8% + 1.3 (4%)
= 13.2%
E(R3) = 8% + 0.5 (4%)
= 10%
E(R4) = 8% + 1.1 (4%)
= 12.4%
E(R5) = 8% + 1.0 (4%)
= 12%
(b) The line connecting these expected returns and betas combination is called Security Market Line (SML).
(c)
Stock E(R) (%) Ri (%) Relationship bet n E(R) & Ri Remarks
1 11.6 12 E(R) < Ri Undervalued
2 13.2 13 E(R) > Ri Overvalued
3 10 11 E(R) < Ri Undervalued
4 12.4 12.5 E(R) < Ri Undervalued
5 12 12 E(R) = Ri No Remarks
(d) Market's Risk Premium = Rm – Rf
= 12% – 8% = 4%

Problem – 23 [NU BBS (Hons.) Fin. 2006]

Assume both portfolios A and B are well diversified, that E(r) of A = .135 and E(r) of B = .148 If the economy has only one
factor, and Beta of A = 1.0. while Beta of B 1.2. What must be the risk-free rate?

Solution
For Company A:
Here,
E(R) = 0.135 βA = 10

E(RA) = RF + (RM – RF) βA

 0.135 = RF + (RM – RF) 1.0
 0.135 = RF + 1 (RM – RF) …………… (1)
For Company B:
Here,
E(R) = 0.148 βB = 1.2

E(RA) = RF + (RM – RF) βB

 0.148 = RF + (RM – RF) 1.20
 0.148 = RF + 1 (RM – RF) …………… (2)
Now, (Eqn. (2) – Eqn. (1)]:
 0.143 = RF + 1.20 (RM – RF)
0.135 = RF + 1 (RM – RF)
(–) (–) (–) .
0.013 = 0.20 (RM – RF)
0.013
 0.20 = RM – RF
 0.065 = RM – RF
.ᱸ. RM – RF = 0.065
Putting the value of (RM – RF) in the Equation – 1:
0.135 = RF + 1 (RM – RF)
 0.135 = RF + 1 (0.065)
 0.135 = RF + 0.065
 0.135 – 0.065 = RF
 0.07 = RF
.ᱸ. RF = 0.07 Or 7%
Therefore, the risk free rate is 7%.

Problem – 24
Security ABC has a β of 0.7 and security KRS has a β of 13. The expected rates of return are 10% and 14%, respectively.
Find the risk-free rate of return?

Solation
We know that,
Change in Return
Risk Premium = Change in Risk
𝐸(𝑅 ) − 𝐸(𝑅 )
 RM – RF = 𝛽𝐾𝑅𝑆 − 𝛽 𝐴𝐵𝐶
𝐾𝑅𝑆 𝐴𝐵𝐶
14 − 10
=
1.3 − 0.7
4
= = 6.667%
0.60
By using Data of Security ABC :
E(RABC) = RF + (RM – RF) βABC Here,
 10 = RF + (6.667) 0.7 E(RABC) = 10
 10 = RF + 4.6669 RF = ?
 10 – 4.6669 = RF (RM – RF) = 6.667%
 RF = 5.3331% βABC = 0.7
Thus, Risk Free Rate = 5.333% (Approx.)

Problem – 25 [NU BBS (Hons.), Part-2, FIN. 2007]

The covariance of returns between stocks X and Y is + 10. Stock X's Variance of return is 12 and Y's Variance of return is 8.
Find out the correlation between stock X and Y..

Solution
COVxy
rxv = σx σy
Here,
10
= 3.4641016 ×2.8284271 COVxy = 10
10
= 9.7979588
Variance of X = σ2x = 12
= 1.0206207 .ᱸ. σx = √12 = 3.4641016
= 1.021 Variance of Y = σ2y = 8
.ᱸ. σY = √8 = 2.8284271
 rxy = Correlation Co-efficient = ?
Thus, correlation between stock X and Y is 1.021.

Problem – 26 [NU BBS (Hons.), Part-2, FIN. 2007]

The expected rate of return on market portfolio is 15%, the standard deviation for the market portfolio is 20% and the risk
free rate is 9%. Determine the slope of CML.

Solution
E(Rm ) − RF
Slope of CML = σm
Here,
15− .09
= .02
E (Rm) = 15% = 0.15
.06
= σm = 20% = 0.20
.20
= 0.30 RF = 9% = .09
Part – C
Problem – 26
The expected return for the market is 12 percent, with a standard deviation of 21 percent. The expected risk free rate is 8
percent. Information is available for five mutual funds, all assumed to be efficient, as follows:
Mutual Funds Standard Deviation (%)
Affiliated 14
Omega 16
Ivy 21
Value line fund 25
New Horizons 30
(a) Calculate the slope of the CML
(b) Calculate the expected return for each portfolio
(c) Rank the portfolios in increasing order of expected return.
(d) Do any of the portfolios have the same expected return as the market? Why?

Solution
Req. (a): Slope of the CML (Capital Market Line) :
E(RM )− RF
Slope of CML = Here,
σm
12 − 8
= 21
E (RM) = Expected Return for the market = 12%
4
= 21
RF = Risk free Rate = 8%
= 0.19047 = 0.1905 σm = Standard deviation of the market return = 21%
Req. (b): Expected return for each portfolio:
Mutual Funds Expected Return:
E(Rm ) − RF
E P = RF + [ σm
]× σP
Here, RF = 8%
E(Rm ) − RF
[ σm
]= 0.1905 [Calculated in Req. (a)]
Affiliated E (RP) = 8 + (0.1905) 14
σP = Standard Deviation = 14% = 8 + 2.667 = 10.667%
Omega (σP = 16%) E (RP) = 8 + (0.1905) 16
= 8 + 3.048 = 11.048%
Ivy [σP = 21%] E (RP) = 8 + (0.1905) 21
= 8 + 4.0005 = 12% (Approx.)
Value line fund [σP = 25%] E (RP) = 8 + (0.1905) 25
= 8 + 4.7625 = 12.7625%
 New Horizons [σP = 30%] E (RP) = 8 + (0.1905) 30
= 8 + 5.715 = 13.715%
Req. (c): Rank on the basis of Expected Returns (In Ascending Order)
Portfolios E (R) Rank
Affiliated 10.667% 5
Omega 11.048% 4
Ivy 12% 3
Value line 12.7625% 2
New Horizons 13.715% 1
Req. (d) : 'IVY' has the same expected return as the market, because it's standard deviation is also same as the market
standard deviation (σm) [i.e., σIVY = σm = 21%]

Problem – 28 [NU. BBS (Hons.) Part-2, FIN. 2009]

The risk-free rate of return is 10%, market rate of return is 16% with a standard deviation of 25%. The following information
are available for mutual funds, all assumed to be efficient :
Mutual Funds Standard Deviation
DBH 16
ICB 18
Grameen 10
You are required to calculate :
(i) The slope of CML
(ii) The expected return for each mutual fund

Solution
Req. (i): The slope of Capital-market line (CML)
E(RM )− RF
Slope of CML = σm
Here,
16 − 10
= 25
E (RM) = Expected Return for the market = 16%
6
= 25
RF = Risk free Rate = 10%
= 0.24 σm = Standard deviation of the market return = 25%
Reg. (ii): Expected return for each portfolio:
Mutual Funds Expected Return:
E(Rm ) − RF
E P = RF + [ σm
]× σP
Here, RF = 10%
E(Rm ) − RF
[ σm
]= 0.24 [Calculated in Req. (i)]
DBH (σP = 16%) E (RP) = 10 + (0.24) × 16
= 10 + 3.84 = 13.84%
ICB [σP = 18%] E (RP) = 10 + (0.24) × 18
= 10 + 4.32 = 14.32%
Grameen [σP = 10%] E (RP) = 10 + (0.24) × 10
= 10 + 2.40 = 12.40%

Problem –29 [NU. BBS (Hons.) Part-2, FIN. 2008]

The expected return for the market is 14% with a standard deviation of 22%. The risk free rate is 5%. The following
information are available for following mutual funds, all assumed to be efficient :
Mutual Funds Standard Deviation
Agroni 15
Brac 17
City 12
Requirement: (i) Calculate the slope of CML
(ii) Calculate the expected return for each mutual fund.

Solution
Req. (i): Slope of CML:
E(RM )− RF
Slope of CML = σm
Here,
14 − 5
= 22
E (RM) = Expected Return for the market = 14%
9
= 22
RF = Risk free Rate = 5%
= 0.4091 σm = Standard deviation of the market return = 22%
Reg. (ii): Expected return for each portfolio:
Mutual Funds Expected Return:
E(Rm ) − RF
E P = RF + [ σm
]× σP
Here, RF = 5%
E(Rm ) − RF
[ σm
]= 0.4091 [Calculated in Req. (i)]
Agroni (σP = 15%) E (RP) = 5 + (0.4091) × 15
= 5 + 6.1365 = 11.1365%
Brac [σP = 17%] E (RP) = 5 + (0.4091) × 17
= 5 + 6.9547 = 11.9547%
City [σP = 12%] E (RP) = 5 + (0.4091) × 12
= 10 + 4.9092 = 9.9092%

Problem – 30 [NU. BBS (Hons.) Part-2, Fin. 2006]

Information available for five mutual funds, all assumed to be efficient, as follows:
Mutual Funds : A B C D E
0(%) : 15 17 22 25 30
E(RM) = 12%, σm = 21%, E(RF) = 8%
Requirements:
(i) Calculate the slope of CML.
(ii) Calculate the expected return for each portfolio.
(iii) Rank the portfolios in increasing order of expected return.
(iv) Do any of the portfolios have the same expected return as the market? Why?

Problem – 31 [NU. BBS (Hons.) Part-2, Fin. 2005]

Given the following information:
Expected return for the market = 12%, standard deviation of market returns = 21%, Risk-free rate = 8%. Correlation
coefficient between –
Stock A and the market = 0.8
Stock Band the market = 0.6
Standard deviation for stock A = 25%
Standard deviation for stock B = 30%
(i) Calculate the beta for stock A and stock B.
(ii) Calculate the required return for each stock.
(iii)
(iv)
Problem -32
Determine the beta values from the given data:
(a) Standard deviation of stock of sunshine Ltd. (σS) = 10 percent
Standard deviation of market portfolio (σm) = 8 percent
Correlation of the share with the market (rsm) = + 0.7
(b) Standard deviation of the portfolio (σP) = 3 percent
Standard deviation of market portfolio (σm) = 2.5 percent
Correlation of the portfolio with market (rpm) = + 0.9

Solution
Req. (a) Beta of Sunshine Ltd. (βS )
We know that, Here, σS = 10%
σ
βS = σ S × rsm σm = 8%
m
.10
= × .7 rsm) = 0.7
.08
= 0.875 βS = ?

Req. (b) Beta of Portfolio (βP )

Here, σS = 3%
σp
βP = σ × rpm σm = 2.5%
m
.03
= .025 × .9 rpm) = 0.9
= 1.08 βP = ?

Problem – 33 [NU BBS (Hons.) Part-2, FIN.2009]

Refer to the following data for computing betas for (i) Security X, (ii) Security Y, (iii) for an equally weighted portfolio of
securities X and Y.
Security (i) Correlation Coefficient Standard Deviation of i (σi)
(i with market)
X 0.5 0.25
Y 0.3 0.30
2
E(Rm) = 0.12, T = 0.05, 𝜎𝑚 = 0.01
Also compute the equilibrium expected return according to the CAPM for securities X and Y and the equally weighted
portfolio of securities X and Y.

Solution
Req. (i) Calculation of Bela of Security X (βX )
We know that, Here, σX = .25
σ 2
βX = σ x × rxm 𝜎𝑚 = .01 .ᱸ. σm = √. 01 = 0.10
m
.25
= .10 × .50 rsm = 0.50
= 1.25 βX = ?
(ii) Calculation of βY :
Here, σy = .30
σ
βY = Y × rym σm = 0.10
σm
.03
= .025 × .9 rym = 0.30
= 1.08 βy = ?
Req. (ii) Portfolio Beta (βP ) :
βP = βX WX + βY WY Here, βX = 1.25 [From Req. (i)]
 = 1.25(.50) + 0.90(50) βy = 0.90 [From Req. (ii)]
= 0.625 + 0.45 Weight = Equally weighted
= 1.075 WX = 0.50
WY = 0.50

Problem – 34 [NU. BBA (Hon's) 2008]

At present, suppose the risk free rate is 12% and the expected return on the market portfolio is 16%. The expected returns
for four stocks enlisted together with their expected beta :
Portfolios Average Return Beta
A 18% 1.35
B 15% 0.85
C 16% 1.20
D 20% 1.75
On the basis of these expectations which stocks are overvalued and undervalued?

Solution
Portfolio Expected return. E(R) =Rf + B (Rm – Rf) Average Return Actual Return Remarks
A E(R) = 12% + 1.35 (16% – 12%)
= 12% + (1.35 × 4%) 18% 17.40% undervalued
= 12% + 5.40%
= 17.40%
B E(R) = 12% + .85 (16% – 12%)
= 12% + (.85 × 4%) 15% 15.40% Overvalued
= 12% + 3.40%
= 15.40%
C E(R) = 12% +1.20 (16% – 12%)
= 12% + (1.20 × 4%) 16% 16.80% Overvalued
= 12% + 4.80%
= 16.80%
D E(R) = 12% +1.75 (16% – 12%)
= 12% + (1.75 × 4%) 20% 19% undervalued
= 12% + 7%
= 19%