Question

QUESTION 1

Given the world economic outlook for the coming years, following information are available for GlaxoSmithKline, a pharmaceutical company in Australia.

	Probability			Possible Return
	0.1			-0.2
	0.15			-0.75
	0.2			0.2
	0.25			0.15
	0.3			0.34

Compute the expected return of GlaxoSmithKline. (please keep 2 decimal points in your working)

QUESTION 2

An investor expects the risk-free rate (RFR) to be 3 percent and the market return to be 8 percent. He also has the following information about three stocks.

d d

Stock

Beta

Current Price

Expecte Price

d

Expecte Dividen

A 1.25 $20 $23

B 1.50 $27 $29

C 0.90 $35 $38

What are the expected (required) rates of return for the three stocks?

What are the estimated rates of return for the three stocks?

Which stock is considered under/over-valued?

(please keep 2 decimal points in your working)

$1.25 $0.25 $1.00

RMIT University, BAFI1042

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QUESTION 3

Poli Advisory Ltd has offered two stocks for Harry Louis to invest. The historical annual returns are provided below for risk-return analysis.

	Year			Stock 1			Stock 2
	1			5.25			-0.58
	2			4.8			7.75
	3			-1.5			3.01
	4			3.94			-2.25
	5			10.05			14.63
	6			-2.36			5.45

What is the expected return for each stock.

Given Harry is a risk-adverse investor, which stock should he invest?

Advise the diversification benefit (if possible) of those two assets’ return correlation since Harry

wants to use both to construct his portfolio.

(please keep 4 decimal points in your working)

Answer 1

1	Probability	Possible Return	Expected Return
	A	B	C = A x B
	0.1	-0.2	-0.02
	0.15	-0.75	-0.1125
	0.2	0.2	0.04
	0.25	0.15	0.0375
	0.3	0.34	0.102
	Total Expected Return		0.05
2		Expected Return	Estimated Return
	A	3% + 1.25 x (8%-3%) = 9.25%	(23-20)÷20 = 15%	Undervalued
	B	3% + 1.5 x (8%-3%) = 10.50%	(29-27)÷ 27 = 7.41%	Overvalued
	C	3% + 0.9 x (8%-3%) = 7.50%	(38-35)÷ 35 = 8.57%	Undervalued
	Decision:	Est. Return > Exp return = undervalued
		Est. return < exp return = Overvalued