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Tutorial Set On Risk and Return

The document is a tutorial set for an Introduction to Finance course at Lancaster University, Ghana, focusing on risk and return concepts. It includes questions on systematic and unsystematic risk, CAPM assumptions, investment advice based on expected returns and betas, as well as portfolio management scenarios. Additionally, it covers the efficient market theory and its three forms.

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Prince Oklu-Darku
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4 views4 pages

Tutorial Set On Risk and Return

The document is a tutorial set for an Introduction to Finance course at Lancaster University, Ghana, focusing on risk and return concepts. It includes questions on systematic and unsystematic risk, CAPM assumptions, investment advice based on expected returns and betas, as well as portfolio management scenarios. Additionally, it covers the efficient market theory and its three forms.

Uploaded by

Prince Oklu-Darku
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd

Lancaster University, Ghana

Introduction to Finance

Tutorial Set (Risk and Return)

Question 1

a. Distinguish between systematic and unsystematic risk

b. State the assumptions underlying CAPM

c. Your friend is considering an investment which has an expected return of 14% p.a. You

estimate that the beta of the investment is 2. Risk free rate as measured by the 91-T/Bills

is 5% and return on the All-Share index in 10%.

RQD: Advice your friend whether he should accept the investment

1B) The risk-free rate is 8% and the market risk premium is also 8%. A firm considers a

project that is expected to have a beta of 1.3. What is the required rate of return on the project?

1C

The security market line depicts:

a. A security’s expected return as a function of its systematic risk.

b. The market portfolio as the optimal portfolio of risky securities.

c. The relationship between a security’s return and the return on an index

d. The complete portfolio as a combination of the market portfolio and the risk-free asset

1
1D

With the context of the capital asset pricing model (CAPM), assume:

 Expected return on the market = 15%

 Risk-free rate = 8%

 Expected rate return of return on XYZ security = 17%

 Beta of XYZ security = 1.25

Which of the following is correct?

a. XYZ is overpriced

b. XYZ is fairly priced

c. XYZ’s alpha is -0.25%

d. XYZ’s alpha is 0.25%

1E

What is the expected return of a zero-beta security?

a. Market rate of return

b. Zero rate of return

c. Negative rate of return

d. Risk-free rate of return

Question 2
2
Sir Makosah, the portfolio manager of the LUG Investment Club has GH¢75,000 to invest. Sir

Makosah is considering the shares of two companies – ABC Ltd and XYZ Ltd. The following table shows

the probability distributions of possible future returns for the two shares:

Probability ABC XYZ

Possible Returns (%) Possible Returns (%)

0.15 20 35

0.2 -10 10

x 12 20

0.3 20 -25

0.1 18 15

Required:

(a) For each of the two shares, compute the following:

i) expected return

ii) variance

iii) standard deviation

iv) coefficient of variation

(b) If Sir Makosah would like to invest in only one of the options, recommend the best

investment option based on the element of risk.

(c) If Sir Makosah invests GH¢30,000 in ABC and GH¢45,000 in XYZ, determine the

following:
3
i) portfolio expected return

ii) portfolio expected risk

iii) the coefficient variation for the portfolio.

(Note: the correlation coefficient between the returns on the shares of ABC and XYZ is

0.65)

Question 3

a) Explain the concept and efficient market


b) Explain the three forms in the efficient market theory

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