1. Explain the importance of Portfolio diversification? How Capital Asset Pricing Model (CAPM) influence portfolio diversification? (16 Marks) 2. Consider the following simplified Arbitrage Pricing Theory APT model (16 Marks) Factor Market Expected Risk Premium 5.4% Interest Spread 1.3% 1.2% Yield spread Calculate the expected return for the following stocks. Assume risk free rate (r) = 2% Factor Risk Exposures Stock Market (b1) A 1.2 0.9 1.0 B C - Interest Rate (b2) 0.6 1.0 1.1 Yield Spread (63) 0.5 0.4 0.5 - r = r + B ( r r ) + ( 1 2 - 1 ; ) + + j k ( 1 k 1 ) fK 3. 4. Security Amount Invested Expected Return Beta A OMR 1,400 4% 0.70 B OMR 7,300 6% 0.65 C D OMR 11,400 13% 1.00 OMR 13,500 10% 1.20 a. Calculate the expected return on this portfolio. b. Calculate the beta of this portfolio? (6 Marks) (10 marks) Project A is expected to produce CF = OMR 120 for each of three years. Given a risk free rate of 4%, a market premium of 6%, and beta of 0.65, what is the PV of the project?.. Now assume that the cash flows change, but are RISK FREE. What is the new PV 1. Calculate the required return using CAPM (r) (3 marks) II. Calculate the Present Value of the Project (PV) (4 marks) III. Calculate the risk free cash flow? (4 marks) IV. Calculate the Present value using certainty equivalent approach based on the risk free cash flows