UNIVERSITY OF GOROKA
DIVISION OF BUSINESS STUDIES
HAF 325 – FINANCIAL MANAGEMENT
ASSIGNMENT # 2
TOPIC 4: RISK & RATES OF RETURN
DUE DATE & TIME - 04:00PM, FRIDAY 23/10/20
SUBMIT TO: P/A - BUSINESS STUDIES
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PART A:
CALCULATIONS
Fully answer these questions by showing any and/ all working out, as well as required
explanations clearly, for full marks.
(Total 36 marks)
1. The risk free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta
of 1.0, what is its expected return? Is this expected return normal or not? Explain why (3 marks)
2. The risk- free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta
of 0, what is its expected return? Is this expected return normal or not? Explain why (3 marks)
3. According to the CAPM (capital asset pricing model), and the security market line is a straight line.
What does the slope of this line (Rise / Run) represent? (2 marks)
4. If the market portfolio has a required return of 0.12 and a standard deviation of 0.40, and the riskfree rate is 0.04, what is the slope of the security market line? (2 marks)
5. For a stock that has a beta of 1.4 and an expected return of 13%, whilst the expected risk
premium on the market portfolio is 6%;
A) What’s the expected return on the market portfolio? (4 marks)
B) What then would be the expected market return? (4 marks)
6. Company A’s stock has an expected return of 0.10 and a standard deviation of 0.25. Company B’s
stock has an expected return of 0.16 and a standard deviation of 0.40. The correlation coefficient
between the two stock’s return is 0.2. If a portfolio consists of 40% of Company A and 60% of
Company B, what’s the expected return of the portfolio? (4 marks)
7. Jane invests 40% of her money in Stock A and 60% in Stock B. Stock A has a beta of 1.2 and Stock B
has a beta of 1.6. If the risk-free rate is 5% and the expected return on the market is 12%, what’s the
Jane’s expected return for her portfolio? (4 marks)
8. Refer to the information below;
Outcome
Recession
Expansion
Boom
Probability
40%
25%
35%
Return
-25%
20%
45%
A). What is the expected variance, & Standard deviation? (4 marks)
B) Graphically illustrate the above findings in both probability distribution and continuous
probability distribution curves, and provide appropriate narratives of the graphs. (You can draw by
hand, or use excel if you know how). (6 marks)
PART B. SHORT ANSWER QUESTIONS:
In a maximum of 200 words, answer the following questions. Kindly refrain from copy pasting
from your lecture slide. Instead, you should try to read and understand the underlying concepts,
and as much as possible, attempt these questions in your own words.
(Total 24 marks)
1. As more stocks are added onto a portfolio, portfolio risk declines only to a point where no
matter how many stocks you own, and even if you own all the stocks available in the market;
you will find yourself unable to diversify away any more risk.
Explain how and why that may be so. (5 marks)
2. Explain the inherent relationship between the risk and return. (5 marks)
3. Explain how inflation impacts on the required rates of return. (5 marks)
4. Explain how the risk and return on an individual stock affects the risk and return of a
portfolio. (5 marks)
5. Explain what it means if a stock has the following betas; (4 marks)
a) b = 0.5
b) b = 2