Question 2 [37]

2.1. A colleague of yours is uncertain what the beta coefficient represents in the context of an investment portfolio consisting of shares.

Explain to this colleague the meaning of the beta coefficient as it is used in the above context. (9)

2.2. An investor is thinking about investing in a portfolio consisting of 60% shares in Lycia Ltd and 40% shares in Trentco (Pty) Ltd. The investor collected the following information about these shares:

Investment scenarios

Probability

Expected return Lycia shares

Expected return Trentco shares

Pessimistic Normal Optimistic

0.10 8.00% 0.60 16.00% 0.30 19.00%

12.00% 18.00% 24.00%

From the information gathered, the investor calculated the following portfolio variables:

Expected return 16.00% 19.00% Standard deviation 3.00% 4.00%

The risk-free rate is 6%.

The market return is 15% and the market risk is 5%.

Required:

Show all calculations and round off all answers to two decimals.

2.2.1. Calculate the following portfolio variables:

(a) The covariance of returns of the portfolio (4) (b) The correlation coefficient of the portfolio (4) (c) Portfolio return (5) (d) The standard deviation of the portfolio (8)

2.2.2. Use the results of your calculations above to demonstrate to the investor how investing in this two-share portfolio compares with other investments in the market and what the investors decision should be.

(7