Question 4

(a) The standard deviations of returns on assets A and B are 15 percent and 21 percent respectively. A portfolio is constructed consisting of one-third of the funds in asset A and remainder in asset B. Calculate the portfolio standard deviation if the correlation of returns between the two assets is:

(i) +0.5 (ii) 0 (iii) +1.0 (12 marks)

Comment on your answers. (120 to 150 words) (8 marks)

(b) If an investment with a beta of 0.8 offers an expected return of 10%, should you proceed with the investment? Determine where will this investment plot in relation to the security market line? Assume that the government bond rate is 4.5%, and the market risk premium is 13.5%. Show your working clearly. (3 marks)

Interpret your answer. (120 to 150 words) (7 marks