a) An investor at the CAPITAL MARKETS has a capital of sh 1,000,000. He intends to apportion this fund to two securities SAFARICOM and NATION MEDIA as follows, Kshs 400,000 in security SAFARICOM and Kshs 600000 in NATION MEDIA. The return depends on the state of economy.

State of economy

Probability

Return of SAFARICOM

RETURN OF NATION MEDIA

BOOM

0.4

11%

12%

AVERAGE

0.3

15%

17%

RECESSION

0.3

13%

20%

Required:

1. Expected return of the portfolio( 5 Marks)
2. Standard deviation for each security(4 Marks)
3. Correlation coefficient between A and B(6 Marks)

QUESTION TWO

a)A portfolio manager decides to hedge his equity portfolio with index future contracts. The correlation between the portfolio value and future price is 0.7.The standard deviation of the portfolio value is 40%and that of future price is 20% per annum. Calculate the hedge ratio and comment on your results (8 marks)

b)Determine the bid and offer quotes of a market in the over the counter market(4 marks)

c)Discuss the overview of derivative markets and how they facilitate the risk management (7marks)

d)From the contexton derivatives discuss the financial risk management(6 marks)