Question

Question 1 You are analysing Yachi Industries. It has a beta of 1.2. The expected return on a market portfolio is 10%, and the risk free rate is 4%. a. What is the expected return of Yachi? (5’) b. If you want to diversify your investment risk, so you decide to invest 60% of your money in Yachi, and the rest of your money in a risk-free government bond. If you know the standard deviation of Yachi is 10%, what is your portfolio risk measured by standard deviation? (10’)

Answer #1

As per Capital Asset Pricing Model | ||||||

Expected Return = RF + β(RM-RF) | ||||||

Given Information | ||||||

Risk free Return(RF) = | 4% | |||||

Return on Market Portfolio(RM) = | 10% | |||||

Beta(β) = | 1.2 | |||||

(a) | As per Capital Asset Pricing Model | |||||

Expected Return = RF + β(RM-RF) | ||||||

= | 4% + 1.2 (10%-4%) | |||||

= |
11.2% |
|||||

(b) | SD of Yachi (SD1) | =10% | ||||

SD of Risk free Investment will always be zero(0). | ||||||

Portfolio |
||||||

S.No |
Particulars |
Weight |
Return |
SD |
||

1 | Share in Yachi | 60% | 11.2% | 10% | ||

2 | Risk free Bonds | 40% | 4% | 0% | ||

SD of Portfolio = | {(SD1*W1)^2 + (SD2W2)^2+2(SD1W1)(SD2W2)* COV(1,2)}^(1/2) | |||||

= | (60%*10%)^2 +(40%*0%)^2 + 2(0) | |||||

= |
6% |

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