Question 4 (11 marks)

1. Assume all investors want to hold a portfolio that, for a given level of volatility, has the maximum possible expected return. Explain why, when a risk-free asset exists, all investors will choose to hold the same portfolio of risky stocks.
2. Briefly discuss why a risky portfolio that lies on the Security Market Line (SML) may not necessarily lie on the Capital Market Line (CML).
3. Suppose that ABC Limited currently has no debt and has an equity cost of capital of 10%. ABC Limited is considering borrowing funds at a cost of 8% and using these funds to finance its R&D expenditures. Assume perfect capital markets. If ABC limited borrows until they achieved a debt-to-value ratio of 20%, what is ABC Limiteds levered cost of equity?
4. If a portfolio has a beta equal to one, this portfolio must be efficient. True or False? Explain.