1. Consider two risky assets (X and Y) that have a standard deviation of 25% and 18% respectively. Compute the variances and standard deviations of portfolio returns for an equal weighted portfolio of the two assets when their correlation of return is: i) _xy = 1.00, ii) _xy = 0.50, iii) _xy = 0, iv) xy= -0.50

[10 marks]

1. The table below contains information based on an analysts forecasts for three stocks. The risk free rate is 8% and the market return is 16%.

Stock	Current stock price (Ksh)	Expected stock price after 1 year (Ksh)	Expected dividend after 1 year (Ksh)	Beta factor
P	25	27	1.00	1.00
Q	40	45	2.00	0.80
R	15	17	0.50	1.20

Required

1. Compute the expected return on each stock [3 marks]
2. Compute the required return on each stock [3 marks]
3. Determine whether each stock is undervalued, overvalued or correctly valued [3 marks]
4. Outline an appropriate trading strategy [3 marks]
5. What are the limitations of the capital asset pricing model when used to make investment decisions [3 marks]

ANSWER AS ONE QUESTION