QUESTION THREE

a. The Y-axis intercept of the Security Market Line (SML) indicates the required rate of return on an individual stock with a beta of 1.0.

i. True

ii. False

b. State which type of risk each of the following are:

i. Labour strikes

ii. Rising inflation

iii. Equipment failure

iv. Management incompetence Currency BID/ Buying Ask/ Selling US Dollar $ 10 11 GB Pound 14 15 Euro 11 12 Rand R 0.6 0.7 4

c. Using the table below, calculate the following for both stocks:

State of Economy	Probability	Returns of Stock A	Returns of Stock B
Fair	0.4	15%	12%
Great	0.3	25%	19%
Poor	0.3	-10%	8%

i. What are the expected returns and standard deviations for these stocks?

ii. Using the information in the previous problem, suppose you have K 20, 000 in total. If you put K 15, 000 in Stock A and the remainder in Stock B,

what would be the expected return, covariance and standard deviation of your portfolio? d. Explain the function of the SML. e. If the risk-free rate is 8 percent, the expected return on the market is 13 percent, and the expected return on Security J is 15 percent, then what is the beta of Security J?