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Risk and Return (a) You invest funds in a stock market index fund whose share price is currently K100, and your time horizon is one
Risk and Return (a) You invest funds in a stock market index fund whose share price is currently K100, and your time horizon is one year. You expect the cash dividend during the year to be K4. Suppose your best guess is that the share price will be K110. Calculate the following: expected dividend yield; holding period return (HPR); Capital gains yield and total holding period rate of return. (5 marks) (b) You buy a K10 000 face value Treasury Bill in one month for K9 900. Calculate your holding period return. (5 marks) (c) A share of stock A is selling at K23.50. A summary of the uncertainty about next years holding period return with three possible scenarios: Business Conditions Scenario,s Probability, p End of Year Price High Growth 1 0.35 K35 Normal Growth 2 0.30 K27 No growth 3 0.35 K15 Annual dividends are K4.40, K4 and K4 under the different business conditions High, Normal and No growth, respectively. Required: (i). Calculate the annual holding period returns for each of the three scenarios. (3 marks) Calculate the expected HPR and the standard deviation of the HPR. (2 marks) (iii). A financial analyst forecasts the return on the LuSE All share index portfolio over the coming year will be 10 %. The one year T-bill rate is 5 %recent returns of the Index suggest a standard deviation of returns to be 18 %. What does this information suggest about the degree of risk aversion of the average investor assuming the average portfolio resembles the LuSE All share index? (5 marks) What is the Sharpe measure of the portfolio above? (5 marks) (d) If the interest rate on a one year CD is 8 %, and you expect inflation to be 5 % over the coming year. What is the real rate of return? (2 marks) Suppose the real interest rate is 3 % per year, and the expected inflation rate is 8 %. What is the nominal rate of interest? (2 marks) Suppose the expected inflation rate rises to 10 %, but the real rate is unchanged. What happens to the nominal interest rate? (1 marks) [TOTAL: 30 MARKS]
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