Self Test 8

i. If an investor were more risk averse than average, what portfolio beta would give him a less-than-average amount of systematic risk?

ii. What do you think is the beta for a brewing company like SABMiller low or high? Why?

iii. Suppose that the risk premium on the market portfolio is 7%, the risk-free rate is 3%. What is the expected return on a portfolio that is 75% invested in Salama Breweries Ltd (assumed beta = 0.80) and 25% invested in a market index?

iv. The risk-free rate is 3% and the expected return on the market portfolio is 14%.A firm is considering a project with an estimated beta of 1.5. What is the required rate of return on the project?

Self Test 10

Assume a market with two market factors F1 , and F 2 that have zero expectation and zero covariance. The return of an individual security, i, at any given point of time t, Ri,t , in this market is generated by a two-factor model. There are four securities in this market that have the following characteristics:

Security	1	2	E(Ri,t)
A	1.0	1.5	20%
B	0.5	2.0	20%
C	1.0	0.5	10%
D	1.5	0.75	10%

Where 1 and 2 are the respective betas (risk indicators) for the two factors Further, the market is assumed to be perfect with possibility of short sales and no transaction costs.

Provide your response to each of the following requirements:

(a) Each of two Investors, X and Y, is interested in creating a portfolio containing (long or short) two of these securities with a return that does not depend on the market factor, F1,t , in any way that is, factor F 1,t has zero effect on the portfolio beta. Investor X is considering securities A and B while Investor Y is considering securities C and D.

(i) Construct the portfolio for investor X and compute the portfolios expected return (Rp,t ) and the beta coefficient (p )

(ii) Construct the portfolio for investor Y and compute the portfolios expected return (Rp,t ) and the beta coefficient (p )

(iii) Comment on the risk and return of the portfolio and if you find them consistent with the risk return trade-off notion.

(b) Suppose the risk-free asset in market has expected return equal to 5 percent, 1 = 0 and 2 = 0. Does the market present arbitrage opportunity to any of the two investors? If yes, explain, in details, the strategy that the investor should implement to exploit the arbitrage opportunity.

(c) What effect would the existence of any arbitrage opportunities have on the capital markets for these securities in the short and long run?