Question1

1. Describe and illustrate the expected relationship between risk and expected return based on security market line (SML) (7mark)
2. Hwang DBS Bhd has identified three potential stocks to buy in FBM KLCU but will only pick two to be added in the portfolio. The following information has been collected:

   	AirAsia	Daya Material	Muhibbah Engineering
   Expected return	12%	25%	18%
   Standard deviation of return	2.2	5.9	3.4

Covariances of returns between companies
AirAsia and Daya Material	8.2
AirAsia and Muhibbah Engineering	2.5
Daya Material and Muhibbah Engineering	17.6

(i)Estimate the correlation coefficients between each of the three possible portfolio combinations and explain the implications of these coefficients for portfolio risk. (9mark)

(ii)Calculate the expected rate of return and standard deviation for each of the three possible 2-stock portfolios, and indicate which portfolio has the most efficient risk-return profile. (14mark)