Question1

i) Explain the difference between total risk of an asset as measured by standard deviation, and market risk as measured by Beta. Which risk measure is appropriate when deciding whether to invest in a stock? Which one is more appropriate when deciding whether to invest in a market fund?

ii) State three biases investors may have that makes them less than fully rational. Choose one of those three biases and provide a strategy with which a fully rational agent can take advantage of the bounded rationality of other investors.

2. The company CoupeduBois Inc. is comparing three projects A, B andC that are mutually exclusive, and whose returns depend onthe followingmacroeconomic forecasts. In the following table, M denotes the market portfolio.Market conditionsprobR(M)R(A)R(B)R(C)Good0.515%20%15%50%Bad0.40%2%8%-20%Very bad0.1-10%-20%-6%-50%The risk-free rate is 4% and the firms cost of capitalis 11%. Fill in the table below, rank the different projectsaccording to the Sharperatio criteria.Finally calculate each projects expected returns according to the CAPM and conclude on whether or not to accept the project.MABC Average returns Standard deviation Sharpe ratio Rank projects By Sharpe ratio Beta