Assume you have been asked by rich businessman, Mr. Rizwan to seek your professional advice

on investment. He has an extra of AFN 2 million which he wishes to invest in share market. Being

risk averse by nature and a first timer to secondary market, he makes it very clear that the risk

should be minimum. Having done some research in this field, you recommend to him a portfolio

of two shares - stocks of ONGD and BPDL company. You tell him that both are reputed,

government controlled companies.

You have the following data of the market available to you:

Period Market return (%) Return (%) on

ONGD BPDL

-------- ------------- -------------------------------

1 10 18 8

2 12 16 10

3 8 12 14

4 -6 (12) 20

5 -4 -7 16

6 10 16 8

The current market price of a share of ONGD is AFN. 1200 and that of BPDL is AFN. 423. On

the future returns of the two stocks and the market, you are able to obtain the following forecast from

a reputed firm of portfolio managers.

State of the Probability Returns (in percentage) on

Economy Treasury ONGD BPDL Market Index

Bills

-------------------------------------------------------------------------------------------------------

Recession 0.3 7 9 15 (2)

Normal 0.4 7 18 10 14

Boom 0.3 7 25 6 20

The firm also informs you that they had very recently made a study of the ONGD stock and

can advise that its beta is 1.65. Mr. Rizwan requests you to answer the following questions:

a. What is the beta for BPDL stock? (4 marks)

b. What is the covariance of the returns on ONGD and BPDL? Use the forecasted returns to

calculate this. (4 marks)

c. If the forecasted returns on ONGD and BPDL are perfectly negatively correlated ( = -1),

what will be expected return from a zero risk portfolio? (4 marks)

d. What will be the risk and return of a portfolio consisting of ONGD and BPDL stocks in

equal proportions? (2 marks)

e. What is the scope for appreciation (overvalued, undervalued, or fairly valued) for the two

stocks?