Answer the following independent questions.

a) Explain why and how a change in interest rates on other financial assets will affect the required rate of return on equity. (2 marks)

b) An analyst has provided you with the following information about the common shares of two companies. Bloxam Inc. and Adelaide Ltd.

Common Shares Bloxam Adelaide

Beta 1.25 0.8

Expected rate of return 9.5% 6.0%

Standard deviation of return 11% 16%

Market price of risk 5% 5%

Risk-free rate of return 2.5% 2.5%

i) Indicate whether a well-diversified investor would prefer to invest in the shares of Bloxam or the shares of Adelaide. Show all calculations.

ii) Indicate whether an investor who can invest in the shares of only one company would prefer to invest in the shares of Bloxam or Adelaide.

iii) Identify the circumstances in which an investment in both shares would lead to benefits from diversification. Provide an example of how such circumstances might arise.