Question One:

Dan Tajiri an investment specialist has been entrusted with sh.10, 000,000 by a unit trust and instructed to invest the money optimally over a 2 year period. Part of the instructions are:

• The funds be invested in one or more of the four specified projects and in the money market.
• The four projects are not divisible and cannot be postponed
• The unit trust requires the return of 24% over the two years.

The following are details of the investment in the projects and the money market.

Initial ExpectedReturn over standard deviation

Cost the two years return over the two years

(Shs.000) % %

Project 1(p₁) 6,000 22 7

Project 2(p₂) 4,000 26 9

Project 3(p₃) 6,000 28 15

Project 4(p₄) 6,000 34 13

Money market (MM) 1,000(minimum) 18 5

The correlation coefficients of returns over the 2 years are as follows:

Between Between projects Between projects between money market

Projects and market portfolio (MP) and the money market (MM) and market portfolio

P₁ and p₂ = 0.7 p₁ and MP = 0.68 p₁ and MM = 0.4 MM and MP = 0.4

P₁ and p₃ = 0.62 p₂ and MP = 0.65 p₂ and MM = 0.45

P₁ and p₄ = 0.56 p₃ and MP = 0.75 p₃ and MM = 0.55

P₂ and p₄ = 0.57 p₄ and MP = 0.88 p₄ and MM = 0.6

P₃ and p₄ = 0.76

Over the two-year period the risk free rate is estimated to be 12 %, market portfolio return is 25% and the variance of returns on the market is 289 %

Required: On basis of two asset portfolios:

i)Use portfolio theory to determine how DanTajiri should invest the shs10 million (15 Marks)

ii)Using the capital asset pricing model advise how Dan Tajiri should invest the sh.15 Million

( 30 Marks)