Q1. (20 marks) Consider the CEO of "Hercules Bank Limited" who is trying to tailor the needs of a corporate client. For analytical reasons and tractability of results the CEO is employing the CAPM theoretical model and the following historical stock and market returns. YEAR WF R starket PROBABILITY 2001 2002 2003 2004 2005 0:15 0.25 18% 32% 17% 22% 19% 26% 21% 19% 20% 16% 21% 25% | 22% 21% 26% 0.15 0.25 Assume that the risk free rate is 5% 1. 2. 3. 4. What are the betas of BOA and WF respectively? Are the stocks of BOA and WF aggressive or defensive stocks? What is the slope of the SML line for the BOA and WF stocks respectively? Draw the SML diagram for both stocks and the Market Portfolio and advice the CEO if these stocks are overvalued or undervalued. What are the market risk and the risks of BOA and WF respectively? What is the slope of the CML line for the BOA and WF stocks respectively? 5. 6. Why do we denote it by the term reward/risk ratio? Draw the CML for both stocks 7. Are the expected and the required rates of return for BOA and WF stocks 8, 9. Comment on your results analytically respectively equilibrium returns? Assume weights 50% for BOA and 50% for WF. What is the beta of the portfolio? Is it an aggressive or a defensive portfolio? What do we mean by the term Efficient Frontier