8 The Security Market Line (SML). Wendy James owns a portfolio consisting of the following five shares (the data is illustrative not actual):

Share Weighting, Wi Beta, βs Expected Return, E(rs)

Airtours 0.20 1.50 15%

Bass 0.15 1.10 19%

Manchester United 0.25 1.20 20%

Marks & Spencer 0.30 0.95 18%

Scottish & Newcastle 0.10 0.80 14%

The risk-free rate is 7 per cent and the expected return on the market is 15 per cent.

(a) Wendy, who has just been reading a book on investment management, has asked for your help to:

(i) calculate the expected return from the portfolio, E(rp).

(ii) calculate the portfolio beta, βp.

(iii) draw the security market line (SML) and plot the shares on the graph,

(iv) determine from the graph which shares appear to be ‘superior’ investments and which appear to be ‘inferior’ investments.

(b) What comments and observations would you make about your graph?

(c) Briefly discuss two factors which may cause the SML to shift.