Question 4

a Comment on whether the following statements are true or false, with an explanation:

i If the CAPM is valid, investors require a higher return for holding highly volatile investments.

ii If the CAPM is valid, you will have a portfolio with a beta of 0.60 by investing 60% of the investment budget in market portfolios and the remainder in T-bills.

iii If the CAPM is valid, a portfolio with a negative beta must also have a negative expected rate of return.

b One-D Capital is one of the top private equity firms in Hong Kong. After the weekly investment meeting held yesterday, the company has shortlisted the following projects to invest in:

Project code name	Harry	Liam	Niall	Zain
Expected return	17%	19%	12%	11%
Beta	1.5	2.0	1.25	0.75
Standard deviation	35%	25%	20%	40%

The risk-free rate and expected market return are 4.0% and 12% respectively, and shareholders in the company are well diversified by investing in numerous different investments.

Answer the following questions:

i Which project(s) is/are attractive to One-D Capital? Provide reason(s) to support your decision. (10 marks)

ii Refer to Unit 2, Figure 2.8 of the course material. Draw the security market line (SML) and plot the location of the four projects. Under CAPM theory, what can you tell with your graph about the acceptance/rejection of investment projects?