Again Mid
Again Mid
Again Mid
You are given the following information about a portfolio consisting of stocks A, B and C:
You have $20000 invested in A with an expected return of 8%; you have $30000 invested in B
with an expected return of 12%; and $50000 invested in C with an expected return of 16%.
What is the expected return of the portfolio? Show you calculations below. *
Total investment = 20000+30000+50000 = 100000
Expected return of portfolio = (20000/100000)×8%+ (30000/100000)×12%+
(50000/100000)×16% = 13.2%
13.2
10.4
9.8
12.3
Other:
2a. If your objective is to reduce the standard deviation of returns on a portfolio by the
greatest amount, you should add a security: *
2 points
that has a lower standard deviation of returns than other securities in the portfolio
That has a beta less than one
That has returns that are uncorrelated with the returns on all other securities in the portfolio
That has returns that are positively correlated with the returns on other securities in the portfolio
3a. If a Treasury bill pays 5%, which of the following would definitely not be chosen by
a risk averse investor: *
2 points
4a. Which of the following is not possible when two securities are positively
correlated. *
2 points
6b. Provide your rationale for selecting your answer to 6a. above. *
Risk neutral investors are the investors who only considers the potential gain and
ignores the risk. In the above options, they will not invest in the 1 st four options as
borrowing at risk free rate and investing it in risky assets would yield in higher returns
at the expense of higher risk as the risk and return linearly increase along the CML.
8a. Give four arguments in favour of adding international securities to your portfolio. *
(a) It increases the investment choices in order to get higher return at a lower risk level
(b) It provides opportunity to invest in international securities which might yield higher
returns compared to the local securities, especially in emerging markets.
(c) By investing in the countries which has negative correlation with the local country’s
economy provides the opportunity to diversify the portfolio
(d) Investors can take the advantage of exchange rate fluctuation by investing in
foreign market when the local currency is strong and take back the return when the
local currency devaluates.
8b. There are a number of potential problems associated with moving away from a domestic-
securities-only orientation. Identify and explain four of the potential problems. *
(a) Country specific political risk raises concerns for the investment in that country
(b) The exchange rate may move against the benefits of the investor and might result
in loss for the investor
(c) There might be liquidity risks in some countries where it would be difficult to sell off
the investment and to get the investment return to the local country
(d) Many of the governments in the emerging economies have additional taxation for
the international investors
9b. There many different sources of risk that need to be considered when investing. Identify
and explain 3 different types of risk that an investor needs to understand. *
There are five different types of risks to be considered while investing and three of
them are provided below:
(a) Business risk is the risk of unstable income flow from any business which leads to
uncertain income flow to the investors as well. When any business like restaurant has
stable income flow the business risk is deemed as low compared to any art gallery
where the income flow is highly uncertain. Higher the business risk, higher the risk
premium charged by the investors.
(b) Financial risk arises when a firm is highly leveraged and incurs huge debt servicing
cost as it reduces the income stream to the common shareholders or investors. Higher
the leverage for financing fixed assets, higher the financial risk of a firm. For any firm
with increased financial risk, the investors should claim for risk premium as
compensation for their additional risk.
(c) Liquidity risk is assumed by the investors for any asset in the secondary market
regarding the quick salability at less or no loss of the value. If the asset demands
higher time to sale or quick sale at a discounted price then the liquidity risk is higher.
Along with the above mentioned risks, there are exchange rate risk and country risk
which are which are not under control of the investor, hence considered as systematic
risk which cannot be diversified. And the investor must charge higher risk premium if
the above risks are higher in terms of investment.