Topic: Portfolio Theory and CAPM (Risk and return)

QUESTION 1 The Finance Manager of Mekar Indah Bhd proposes two risky securities and risk-free securities for investment consideration which are currently traded at the stock exchange. The following information shows the estimated returns of the two securities; Pluto Bhd and Venus Bhd in different economic condition. Recession 0.30 Normal 0.40 Boom 0.30 State of economy Probability Estimated return (%) Pluto Bhd Venus Bhd 13 -12 11 10 18 8 The expected returns and standard deviation of the market are 6.30% and 8.13% respectively. The covariance between Pluto Bhd and the market is 93.25 while the covariance between Venus Bhd and the market is 58.21. Mekar Indah Bhd plans to bid for auction the Malaysian Treasury Bills issued by the government which offers the rate of return at 4%. Required: Calculate the expected return, standard deviation and beta of the following securities: a. i. ii. Pluto Bhd Venus Bhd Malaysian Treasury Bills (10 marks) b. Applying the Capital Asset Pricing Model (CAPM) and assuming its hold true: i. ii. Evaluate whether the above portfolio are correctly priced or otherwise Advise the choice of option of investment for Mekar Indah Bhd (5 marks) c. Explain on the Beta implying in (a) above with regard to systematic risk. (2 marks)