(a) Determine Ross Bhd.’s expected return and portfolio beta.

Does this portfolio have

more or less systematic risk than an average asset? (8 marks)

Subsidiary Expected Return Weightages

(%)

Technology services 6 5,000 / 14,000 = 0.3571

Health services 12 2,000 / 14,000 = 0.1429

Commercial services 15 3,000 / 14,000 = 0.2143

Construction 18 4,000 / 14,000 = 0.2857

services

Expected Return = Expected Return x Weightages

= (0.06 x 0.3571) + (0.12 x 0.1429) + (0.15 x 0.2143) + (0.18 x 0.2857)

= 0.122 @ 12%

Subsidiary Amount invested (RM’000) Weightages

Technology services 5,000 5,000 / 14,000 = 0.3571

Health services 2,000 2,000 / 14,000 = 0.1429

Commercial services 3,000 3,000 / 14,000 = 0.2143

Construction 4,000 4,000 / 14,000 = 0.2857

services

Portfolio Beta = Beta x Weightages

= (0.60 x 0.3571) + (0.95 x 0.1429) + (1.10 x 0.2143) + (1.40 x 0.2857)

= 0.99
A beta less than one indicates less than proportional fluctuation relative to the market, this
portfolio has less systematic risk than an average asset.
A beta of one indicates proportional fluctuation and systematic risk; a beta greater than one
indicates more than proportional fluctuation compared to market; and a beta less than one
indicates less than proportional fluctuation relative to the market.

(b) If the risk-free rate is 4% and the market risk premium is 8%, calculate Ross Bhd.
shareholder’s required rate of return. (3 marks)

Required Rate of Return = Rf + Beta (Rm - Rf)

= 0.04 + 0.99 (0.08)

 = 0.12 @ 12%

(c) Explain with reasons how diversification reduces risks. (4 marks)

Diversification is an investing strategy used to manage risk. Rather than concentrate money
in a single company, industry, sector or asset class, investors diversify their investments
across a range of different companies, industries and asset classes.

When you divide your funds across companies large and small, at home and abroad, in both
stocks and bonds, you avoid the risk of having all of your eggs in one basket.

(d) Explain THREE (3) advantages and TWO (2) disadvantages of the Capital Asset
Pricing Model (CAPM). (10 marks)
Advantages
1. Provides a benchmark: CAPM provides a standard against which the performance of a
portfolio or individual security can be measured.
2. Incorporates market risk: CAPM accounts for market risk, which is a crucial factor in
investment decisions. By considering market risk, investors can make informed decisions
about potential investments.
3. Helps in determining required rate of return: CAPM helps investors determine the required
rate of return for a given investment based on its risk profile. This can aid in portfolio
management by helping investors optimise their portfolio for risk and return.
Disadvantages
1. Limited in scope: CAPM only takes into account market risk and assumes that all investors
have access to the same information. This means that it may not fully capture other factors
that can impact the value of an investment.
2. Relies on historical data: CAPM relies on historical data to estimate market risk and
return, which may not always be a reliable predictor of future performance.
(i) Calculate the growth rates of Alpha Bhd. and Beta Bhd. (4 marks)
Growth rates = (Retained Earnings / EPS) x Return on Equity
Retained Earnings = EPS - Dividend
Alpha Bhd. = [RM(10-8) / RM10] x 0.1
= 0.2 x 0.1
= 0.02 @ 2%
Beta Bhd. = [RM(15-1) / RM15] x 0.12
= 0.933 x 0.12
= 0.1120 @ 11.2%

(ii) Calculate the stock prices of Alpha Bhd. and Beta Bhd. (4 marks)

P0 = D0 (1+g)r - g
Alpha Bhd. = 8 (1+0.02)0.12 - 0.02
= 8.16 / 0.1
= RM81.5
Beta Bhd. = 1 (1+0.112)0.12 - 0.112
= 1.112 / 0.008
= RM139

(iii) Explain with reasons the differences in the stock prices of Alpha Bhd. and Beta Bhd.
(4 marks)

Beta Bhd. has a higher growth rate, future value higher, demand higher, higher valuation

(b) Briefly describe THREE (3) factors for a high plowback ratio. (6 marks)

(c) Explain what is a “default risk” in bonds and how do investors respond to it. (7
marks)
Default risk in bond investing refers to the chance that a bond-issuing company or
government would fail to make its debt and interest payments. As a bond investor, you can
lose 100% of your investment along with uncollected interest. But there are several steps you
can take to hedge against default risk.
In addition to the ratings, investors can measure a bond’s risk of default by using the interest
coverage ratio. You can calculate this by dividing a company’s earnings before interest and
taxes (EBIT) by its periodic debt interest payments. Companies with higher interest ratios
may be less likely to default.