The following information is relating to questions 1 to 3.

Consider the following probability distribution for stocks A and B:

State	Probability	A	B
1	10%	10%	8%
2	20%	13%	7%
3	20%	12%	6%
4	30%	14%	9%
5	20%	15%	8%

Q1. The expected rate or return of Stocks A and B are _____ and _____, respectively.

1. 13.2%;9%

2. 14%; 10%

3. 13.2%; 7.7%

4. 7.7%; 13.2%

Q2. The standard deviations of Stocks A and B are _____ and _____, respectively.

1. 1.5%; 1.9%

2. 2.5%; 1.1%

3. 3.2%; 2.0%

4. 1.5%; 1.1%

Q3. You put up K50 at the beginning of the year for an investment. The value of the investment grows 4% and you earn a dividend of K3.50. Your yield was ____?

1. 4.00%

2. 3.50%

3. 7.00%

4. 11.00%

Q4. The market risk premium is defined as __________.

1. The difference between the return on an index fund and the return on Treasury bills

2. The difference between the return on a small firm mutual fund and the return on the Standard and Poor's 500 index

3. The difference between the return on the risky asset with the lowest returns and the return on Treasury bills

4. The difference between the return on the highest yielding asset and the lowest yielding asset

Q5. Let's say that you invested K10,000 in Macrosoft 10 years ago, and that your shares (including reinvested dividends) are currently worth K23,800. Using this information, your annualized return was:

1. 9.06%

2. 138%

3. 238

4. 5831.36%

Q6. Olivia is a risk-averse investor. Alex is a less risk-averse investor than Olivia. Therefore,

1. For the same risk, Alex requires a higher rate of return than Olivia.

2. For the same return, Alex tolerates higher risk than Olivia.

3. For the same risk, Olivia requires a lower rate of return than Alex.

4. For the same return, Olivia tolerates higher risk than Alex.

Q7. A negative covariance between two variables indicates that

1. The two variables move in different directions

2. The two variables move in the same direction

3. The two variables are low risk

4. The two variables are high risk

Q8. An impending recession is a form of:

1. Interest rate risk.

2. Inflation risk.

3. Market risk.

4. Financial risk.

Q9. Given the following correlations between pairs of stocks, a portfolio constructed from which pair will have the lowest standard deviation?

Correl(A,B) = 0, Correl(C,D) = 1, Correl(G,H) = -0.75, Correl(I,J) = -0.50.

1. Pair A,B

2. Pair C,D

3. Pair I,J

4. Pair G,H

Q10. If investors expected inflation to increase in the future, and they also became more risk averse, what could be said about the change in the Security Market Line (SML)?

1. The SML would shift up and the slope would increase.

2. The SML would shift up and the slope would decrease.

3. The SML would shift down and the slope would increase.

4. The SML would shift down and the slope would decrease.

SECTION B: ANSWER ALL QUESTIONS

QUESTION ONE

1. You are presented with the following two stocks.

Stock	Beta ()	Expected Return
A	1.4	25%
B	0.7	14%

Assuming that the Capital Asset Pricing Model (CAPM) assumptions hold true, calculate:

1. The return on the market. [4 MARKS]

2. The risk-free rate. [4 MARKS]

3. The risk premium for stock A. [1 MARKS]

2. You are presented with the following two stocks in an excel spread sheet.

Asset	Correlation Coefficient of the Asset with the Market	Standard Deviation of the Asset
A	0.5	25%
B	0.3	30%
Market	1	10%

Assuming the markets return is 12% and the risk free rate is 5% calculate:

1. The Beta () value for Asset A. [3 MARKS]

2. The Beta () value for Asset B. [3 MARKS]

[TOTAL: 15 MARKS]

QUESTION TWO

1. A portfolio is consisting of two stocks has the following parameters:

	A	B
Standard Deviation	25%	5%
Proportion of Portfolio	20%	80%
Variance of Portfolio comprising of A and B	50%

Calculate the correlation coefficient of asset A and B. [7 MARKS]

2. Define the concept of risk aversion. [3 MARKS]

3. If a portfolio has a positive weight for each asset, can the expected return on the portfolio be greater than the return on the asset in the portfolio that has the highest return? Can the expected return on the portfolio be less than the return on the asset in the portfolio with the lowest return? Explain. [5 MARKS]

[TOTAL: 15 MARKS]

QUESTION THREE

1. Musonda Ltd.s last dividend was K1.25. You plan to purchase the stock because you feel that the growth rate will increase to 7% for the next 3 years and 6% thereafter. You require a 16% return, calculate the value of the stock at the end of year one (1). [10 MARKS]

2. The preferred stock of Clara Inc. has a par value of K100 and a K1 dividend payout per month. You require an 11% per annum rate of return on this stock. What is the maximum price you would pay for it? Would you buy it at a market price of K96? [5 MARKS]

[TOTAL: 15 MARKS]

QUESTION FOUR

Rob has K40,000 in his margin account and he wants to use the money to buy shares of the ABC company. The initial margin requirement is 40% and ABCs stock price is currently K50. Ignore taxes, commissions and interest on the amount borrowed.

1. How many share of ABC can Rob buy from his margin account?

[4 MARKS]

2. What is Robs percentage return if he buys the stock on margin and the price increases to K55? [4 MARKS]

3. If the maintenance margin is 30%, at what price would Rob receive a margin call from his broker? [7 MARKS]

[TOTAL: 15 MARKS]

QUESTION FIVE

	31st December 2002		31st December 2003
	Price (K)	Shares Outstanding	Price (K)	Shares Outstanding
Stock K	20	100 000 000	32	100 000 000
Stock L	80	2 000 000	45	4 000 000
Stock M	40	20 000 000	42	000 000

1. Form a price-weighted index with the above stocks in the table. What was the percentage return on the index during 2003? [7 MARKS]

2. Form a market-weighted index with the above stocks in the table. What was the percentage return on the index during 2003? [4 MARKS]

3. Form an equally-weighted index with the above stocks in the table. What was the percentage return on the index during 2003? [4 MARKS] [TOTAL: 15 MARKS]

QUESTION SIX

Mr. Franklin is 70 years of age, is in excellent health, pursues a simple but active lifestyle, and has no children. He has interest in a private company for K90 million and has decided that a medical research foundation will receive half the proceeds now; it will also be the primary beneficiary of his estate upon his death. Mr. Franklin is committed to the foundations well-being because he believes strongly that, through it, a cure will be found for the disease that killed his wife. He now realizes that an appropriate investment policy and asset allocations are required if his goals are to be met through investment of his considerable assets.

Currently, the following assets are available for use in building an appropriate portfolio:

• K45.0 million cash (from sale of the private company interest, net of pending

• K45 million gift to the foundation)

• K10.0 million in Stocks and bonds

• K9.0 million Warehouse property (now fully leased)

• K1.0 million Home

Formulate and justify an investment policy statement setting forth the appropriate guidelines within which future investment actions should take place. Your policy statement must encompass all relevant objective and constraint considerations.

[TOTAL: 15 MARKS]