Risk and Return

1. The expected annual returns are 15% for investment 1 and 12%for investment 2. The
standard deviation of the first investment return is 10%; the second investment return has a
standard deviation of 5%. Which investment is less risky based on coefficient of Variation?
2. Using the basic CAPM formula, find the answer for following questions. a) Find required
return, when beta .90, and risk free and market return are 8% and 12% respectively. b) If
required return 15% and beta 1.25, as well as market premium 7%, what is risk free rate?

3. You have been given expected return for three projects likely A, B, C, individually over the
period 2010-2013.

Year Asset A Asset B Asset C

2010 16% 17% 15%

2011 17 16 16

2012 18 15 17

2013 19 14 18

Using these assets, you have isolated the three investment alternatives shown in the table.
Alternatives Investment
1 100% of asset A
2 50% of asset A and 50% of B
3 50% of Asset A and 50% of C

a) Calculate expected return for three alternatives. b) Calculate standard deviation.

c) Calculate C V for three alternatives. d) Which one do you recommend?

4. An investor is forming a portfolio by investing SAR 50,000 in a stock “A” that has a beta of 1.5
and SAR 25,000 in stock “B” that has a beta of .90. The return on the market is equal to 6% and risk-
free rate is 4%. What is the rate of return on the investor’s portfolio?

6. Micro pub Inc is considering the purchase of one of two cameras, R and S. Both should provide
benefits over 10 years and each require initial investment of RM4000.
Camera R Camera S
Amount Probability Amount Probability
Initial 4000 1 4000 1
investment
Pessimistic 20% .25 15% .2
Most likely 25% .50 25 .55
Optimistic 30% .25 35 .25
A) Calculate the range for both cameras’. B) Determine the expected value of return for each camera.
C) Calculate portfolio standard deviation. Which camera do you recommend?
7. Wyse‐Tech Corporation is considering three possible capital projects for next year.
Each project has a one year life, and project returns depend upon next year’s state of
the economy. The estimated rates of return are shown below:

State of Probability of Rates of Return For Each Asset if State

the State Occurs
Economy Occurring
Asset Asset Asset
A B C
Recession 0.25 10% 18% 10%
Average 0.50 14% 13% 12%
Boom 0.25 16% 9% 14%
Assume the expected standard deviation of returns are 2.2%, 3.2% and 1.4% for Projects
A, B and C respectively.
a) Find each project’s expected return and coefficient of variation.
b) Which project has the highest risk? Explain.
c) If it were known that project B was negatively correlated with other cash flows
of Wyse‐ Tech, whereas projects A and C were positively correlated, how
would this knowledge affect your answer to part b) above?
d) Assume that Wyse‐Tech is going to invest one‐third of its available funds in
each project. What is the expected rate of return on the three‐asset portfolio?
e) Assume that the standard deviation of the above three ‐asset portfolio is 1.3%.
Explain why the risk of this portfolio is less than the weighted average of the
standard deviations of the three assets in the portfolio.

7. Assuming a risk‐free rate of 8 per cent and a market return of 12 per cent, would a
wise investor acquire a security with a beta of 1.5 and an expected rate of return of
13 per cent?
8. A money manager is holding the following portfolio:
Stock Amount Invested Beta
1 $300,000 0.6
2 $300,000 1.0
3 $500,000 1.4
4 $500,000 1.8
The risk‐free rate is 6% and the portfolio’s required rate of return is 12.5%. The
manager would like to sell all of her holdings of Stock 1 and use the proceed to
purchase more shares of Stock 4. What would be the portfolio’s required rate of return
following this change?

9. Sarah can visualize the expected return, standard deviation and weights as shown below,
with the need to determine the numbers for the empty boxes.
Investment Expected Standard Investment
Fund Return Deviation Weight

S&P500 fund 12% 20% 50%

International 14% 30% 50%

Fund

Portfolio Blank Blank 100%

a) Calculate portfolio expected returns of Sarah’s investment. B) Calculate the portfolios

standard deviation when the co-relation between these assets are 0.20.