Question 5 At the end of the current accounting year, the share price of Rose plc is 50, and the share price of Orchid plc is 100. Both companies have just distributed dividends. It is expected that at the end of next year the share prices and the dividends that will be distributed by Rose plc and Orchid plc, will depend on the conditions of the economic environment, as given in the following table: Economic Company A Company A Company B Company B environment Price at the end Dividend to be Price at the end Dividend to be paid at the end of paid at the end of the year High growth 60 101 Normal growth 55 1 108 3 Recession 50 112 8 The probability of high growth is 30%, normal expansion 50% and recession 20%. of the year of the year the year 2 1 1 Required: a) Estimate the expected returns and standard deviation for the shares of Rose plc. 2 (3 marks) b) Estimate the expected returns and standard deviation for the shares of Orchid plc. (3 marks) c) Estimate the covariance between the returns of the shares of Rose plc and Orchid plc. (3 marks) d) Estimate the correlation coefficient between the returns of the shares of Rose plc and Orchid plc. (3 marks) e) Estimate the risk and returns of a portfolio invested 50% in shares of Rose plc and 50% in shares of Orchid plc. (4 marks) f) Explain why investing in a portfolio is better than investing in a single security. (5 marks) g) Explain the role of the correlation of the returns of two securities in the risk of a portfolio which is invested in these two securities. (4 marks) (Total 25 marks)