Question 1

Differentiate between the terms 'Systematic risk' and 'unsystematic risk.  

What is the meaning of beta and what is it used for?  

1. The following information relating to a portfolio was given to you:

 

Stock	Percentage	Beta
	of portfolio
1	40%	1.00
2	25%	0.75
3	35%	1.50

The risk-free rate is 8 percent and the expected return on the market portfolio is 12 percent.

1. Using CAPM formula, calculate the expected return for stocks 1, 2 and 3.    

1. Sketch the security market line (SML) and show where the securities fit on the graph.  
2.  
3. Interpret the results based on (ii) above and indicate which stock might be undervalued or overvalued