1. Frane Ltd has available two investment opportunities with the following risk return characteristics

	A	B
Expected return	13%	20%
Risk	4%	8%

Frane Ltd plans to invest 65% of its available funds in Security A, and 35% in B. The directors believe that the correlation coefficient between the returns of the securities is +0.2.

(i) Calculate the expected return of the portfolio and the risk of the portfolio.

E(RP)=15.45%

p= 4.18%

This one I have calculated, thank you. (ii) Suppose the correlation coefficient between A and B was -1.0. How should Frane Ltd invest its funds in order to obtain a zero risk portfolio?

by using ( a b ) = a-2ab+b

I have tried, but also don't know how to do. Thank you.

p = (xA) + [(1-x) B] + 2x(1-x) AB AB

= (0.65 x 0.04) + (0.35 x 0.08) + 2(0.65)(0.35)(-0.1)(0.04)(0.08)?

(iii) According to CAPM, The only risk that matters to an investor is non-diversifiable risk. Do you agree with the comment? 2. Both trade-off theory and pecking order theory explain why companies may differ in their levels of gearing. Discuss this statement.