Practice questions

Financial Markets (Term 1)

(CAPM, Portfolio risk and return)

Question 1: Suppose Mr. Jayant, a retail investor have invested only in two stocks, R and S.
You expect that returns on the stocks depend on the following three states of economy, which
are equally likely to happen.
State of Economy Return on Stock R (%) Return on Stock S (%)
• Bear 7.3 -4.7
• Normal 11.5 5.4
• Bull 16.6 24.3
Q1. Calculate the expected return of each stock.
Q2. Calculate the standard deviation of returns of each stock.
Q3. Calculate the covariance and correlation between the two stocks.

Question 2: Mr. Johnson is considering two securities, Y and Z, and the relevant information
is given below:
State of Economy Probability Return on Security X (%) Return on Security Z (%)
Bear 0.6 3.0 6.5
Bull 0.4 15.0 6.5

1. Calculate the expected returns and standard deviations of the two securities.
2. Suppose Mr. Johnson invested $2,500 in Security Y and $3,500 in security Z. Calculate the
expected return and standard deviation of his portfolio.

Question 3: Suppose the current risk-free is 7.6 percent. Zinc Inc. stock has a beta of 1.7 and
an expected return of 16.7 percent. (Assume the CAPM is true)
a. What is the risk premium on the market?
b. Magnet Industries stock has a beta of 1.8. What is the expected return on the Magnet stock?
c. Suppose you have invested $100,000 in a portfolio of Zinc and Magnet, and the beta of the
portfolio is 1.77. How much did you invest in each stock? what is the expected return on the
portfolio?

Question 4: Consider the following two stocks:

Stock i Beta Expected Return
A 1.4 25%
B 0.7 14%
Assume the CAPM holds. Based upon the CAPM, what is the return on the market? What is
the risk-free rate?
Question 5: Consider a portfolio comprised of three securities. The details as follows:

Securities Amount invested ($) Beta Expected return

Gold 1.5 million 1.0 12%
Silver 1 million 1.5 13.5%
Bronze 2 million 0.8 9%

1. Calculate Portfolio beta from the above information.

2. Calculate Portfolio return.

Question 6 : Explore the following topics as assigned in the session 7. We will discuss the
same in next class.
• WIP Vs. CPI (Which is better measure of inflation and why?).
• How does Olympic games affect financial markets? Any impact on Index
values? Explore the previous Olympic events and study its impact on previous
index values. Can it be seen signal for profitable investment?
• Status of Indian debt market. Is it underdeveloped ?