Question 5 24 marks You have been provided the following summary of the performance of stocks A and B of the market index and the risk free rate A B Market Index Risk Free Asset Average annual return 22 14 12 4 Standard deviation of annual returns 20 10 8 Correlation coefficient A and B 0 50 Correlation coefficient A and Market 0 35 Correlation coefficient B and Market 0 25 Which stock is riskier A or B 2 Which stock provides a higher reward to risk 2 What is the lowest risk possible in a portfolio consisting only of A and B What is the composition of such a portfolio 4 2 Can you have a portfolio of only the Market Index and Risk Free Asset such that it has the same risk as the portfolio of A and B above What would be the expected return of this portfolio 4 2 Apply Capital Asset Pricing Model (CAPM) to estimate the expected returns of A and B Compare it to the actual expected returns to decide if A and B are over or under priced by the stock market 2 2 4

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Question 5 [24 marks]

You have been provided the following summary of the performance of stocks A and B; of the market index; and the risk free rate.

	A	B	Market Index	Risk Free Asset
Average annual return	22%	14%	12%	4%
Standard deviation of annual returns	20%	10%	8%
Correlation coefficient A and B	-0.50
Correlation coefficient A and Market	0.35
Correlation coefficient B and Market		0.25

Which stock is riskier A or B? [2]
Which stock provides a higher reward to risk? [2]
What is the lowest risk possible in a portfolio consisting only of A and B? What is the composition of such a portfolio? [4+2]
Can you have a portfolio of only the Market Index and Risk Free Asset such that it has the same risk as the portfolio of A and B above? What would be the expected return of this portfolio? [4+2]
Apply Capital Asset Pricing Model (CAPM) to estimate the expected returns of A and B. Compare it to the actual expected returns to decide if A and B are over or under priced by the stock market. [2+2+4]