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%