Question

Mr. Anderson invested AU$200,000 in stock market in December 2019. He purchased 5,000 shares of ABC Company at AU$40 per share. Expected rate of return on ABC stock and S&P/ASX300 were 14% and 12% respectively at the time of purchase. The rate on T-bill issued by Reserve Bank of Australia (RBA) was 4% in December 2019. Mr. Andrew, neighbour of Mr. Anderson, claims that he is smarter than Mr. Anderson in stock market trading. He also invested AUD$200,000 in the shares of XYZ Company, which had an expected rate return of 16%. Both Mr. Anderson and Mr. Andrew enjoy the same risk-free rate and market return (return on S&P/ASX300). Use CAPM to answer this question (assume both shares are fairly priced).

(i) Who invested in the riskier share? Without any calculation explain your answer in words.

(ii) Now explain your answer in (i) above with numerical calculation

(you must show all relevant workings)

Answer 1