QUESTION ONE

1. Given two assets with the following characteristics:

E(R₁) = 0.12 ₁ = 0.04

E(R₂) = 0.16 ₂ = 0.06

Assume that r_1,2 = -1.00. What is the weight that would yield a zero variance for the portfolio? (3 marks)

1. Briefly explain five fundamental factors that influence the risk premium of an investment.

(5 marks)

2. What is covariance and why is it important in portfolio theory? (5 marks)

3. Briefly discuss the implications of the Efficient Market Hypothesis (EMH) for investment policy as it applies to:

1. Technical analysis in the form of charting. (3 marks)
2. Fundamental analysis. (3 marks)

4. The current dividend, Do, is Ksh5.00. Growth is expected to be 10 percent a year for three years and then 5 percent thereafter. The required rate of return is 15 percent. Estimate the intrinsic value. (4 marks)

5. Discuss why the investment and financing decisions are separate when you have a CML.

(4 marks)

6. The following information describes the expected return and risk relationship for two stocks; A and B.

	Expected return (%)	Standard Deviation (%)	Beta
Stock A	12	20	1.3
Stock B	9	15	0.7
Market index	10	12	1.0
Risk free rate	5

Using the information to compute the alphas both for Stock A and for Stock B and indicate which stock dominates the other. (3 marks)