Monthly Values for the Market Index and the Two Traded Shares.

Month Market index (points)Volcanic Ltd ($) Etna Ltd ($)

1 5600 10.00 16.12

2 5520 9.60 15.87

3 5410 9.00 15.05

4 5340 8.70 14.75

5 5465 9.10 15.00

6 5568 9.60 15.35

7 5615 9.30 15.70

8 5535 8.90 15.90

9 5670 9.70 16.70

10 5800 10.20 17.55

11 5705 9.65 17.25

12 5840 10.45 18.50

13 5800 10.05 18.12

14 5750 9.55 19.00

15 5700 9.05 18.25

16 5840 9.75 19.50

17 5975 10.55 20.00

18 5900 10.10 21.05

19 5870 9.70 20.65

20 5800 9.45 20.20

21 5905 9.95 21.90

22 6100 10.45 22.70

23 6245 11.00 23.40

24 6355 11.35 24.10

25 6490 11.75 25.00

Questions:

1. Using the information given in Exhibit 1, calculate the historical returns for

each company and the market index. With the use of the excel functions

calculate the average monthly return and standard deviation of returns for

each company and the market index. What do your results suggest about the

relationship between risk and return?

2. Using your answers to Question 1, above, and assuming that investors can

only invest in one of the two alternative shares in Exhibit 1, use the average

return and standard deviation to determine which share would be the most

appropriate for a risk-averse investor. Provide numerical justification for your

selection based on the coefficient of variation.

3. Calculate the correlation coefficients between both shares. Provide an

explanation of your results and the implications for diversification.

4. Determine the standard deviation of a two-asset portfolios comprised of Sea

Ltd and Land Ltd; Assume equal weightings of each share within the portfolio.

Interpret your results and comment and illustrate the impact on risk when

combining shares into a portfolio. You will need to quantify the level of risk

reduction resulting from the creation of the portfolio.

5. Determine the systematic risk (Beta) for both shares. Interpret your answers

and make specific reference to how each asset's beta will affect the required

rate of return and each assets price. The use of excel statistical slope functions

should be used to calculate Beta. What limitations are associated with the use

of beat for asset pricing?

6. Assuming a risk-free rate of 3% and market risk premium of 7%, calculate the

required return for both shares. If the future growth in dividends is expected to continuously average 4% for Etna Ltd and 2% for Vocanic Ltd, what value

would you place on each share (use the dividend growth model). What

concerns do you have, if any, in regards to your valuations? NOTE: The last

dividend paid for Etna Ltd was $2.60 and $1.05 by Volcanic Ltd.