Question
4a. Assume that the riskfree rate is 8 percent and that you can invest funds in the market portfolio which has an expected return of
4a. Assume that the riskfree rate is 8 percent and that you can invest funds in the market portfolio which has an expected return of 18 percent and a standard deviation of return of 20 percent. If you have $15,000 available to invest how would you form a portfolio (in terms of dollars invested) with an expected return of 25 percent? Clearly outline each step associated with forming such a portfolio and show all calculations.
b. An equally-weighted portfolio contains ten securities, each with a standard deviation of returns of 25%. If the pairwise correlation of returns for these securities is 0.6 calculate the resulting portfolio's standard deviation of returns. Show all calculations.
c. You have $5,000 available for investment in two securities A and B and a one-year investment horizon. Security A has an expected return of 8% and a standard deviation of 9% while security B has an expected return of 3% and a standard deviation of 16%. If the returns on these securities are perfectly negatively correlated, calculate the expected return of the minimum variance portfolio. Show all calculations.
d. The covariance between the returns of AZA Ltd's shares and the returns of the market portfolio is 0.05. The standard deviation of the return of the market portfolio is 20%. The market risk premium is 4% and the riskfree return is 6%.
Di . Calculate the required return on the firm's shares. Show all calculations.
Dii. If the expected return based only on the constant dividend growth model is 12% are the shares correctly priced? If yes, explain why. If not, what would happen to the share price and why? (No calculations required.)
e. Suppose that all stocks in an equity market can be grouped into two mutually exclusive portfolios (that is, with each stock appearing in only one portfolio): value stocks and growth stocks. Assume that these two portfolios are equal in size by market value and the correlation of their returns is 0.3. Value stocks have an expected return of 14% and a standard deviation of return of 20%. Growth stocks have an expected return of 18% and a standard deviation of return of 24%. If the riskfree rate is 6%, calculate the Sharpe ratio of an equally-weighted portfolio of the value and growth stock portfolios. Show all calculations.
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