INVESTMENT ANSWERS

1D COAT COMPANY

(i) To calculate the mean (expected) NPV of the proposed investment, we need to find the present value
of each cash flow and then sum them up. The formula for calculating the present value of a cash flow is:

PV = CF / (1 + r)^n

where:

PV = present value

CF = cash flow

r = discount rate

n = number of years

Using the above formula, we can calculate the present value of each cash flow as follows:

Year 1:

PV of cash flow 1 = 1,000,000 / (1 + 0.12)^1 = 892,857.14

PV of cash flow 2 = 2,000,000 / (1 + 0.12)^1 = 1,785,714.29

PV of cash flow 3 = 3,000,000 / (1 + 0.12)^1 = 2,678,571.43

Year 2:

PV of cash flow 4 = 2,000,000 / (1 + 0.12)^2 = 1,504,403.36

PV of cash flow 5 = 3,000,000 / (1 + 0.12)^2 = 2,256,605.04

PV of cash flow 6 = 5,000,000 / (1 + 0.12)^2 = 3,760,084.15

Next, we can calculate the expected NPV as the sum of the present values of the cash flows multiplied
by their respective probabilities:

Expected NPV = (0.1 x 892,857.14) + (0.5 x 1,785,714.29) + (0.4 x 2,678,571.43) + (0.3 x 1,504,403.36) +
(0.6 x 2,256,605.04) + (0.1 x 3,760,084.15)

Expected NPV = $3,063,548.33

Therefore, the mean (expected) NPV of the proposed investment is $3,063,548.33.

(ii) To assess the financial acceptability of the proposed investment, we can compare the expected NPV
with the initial investment cost of $3.5 million. Since the expected NPV is greater than the initial
investment cost, the investment is financially acceptable. However, it's important to note that
probability analysis assumes that the cash flows will occur as expected, which may not always be the
case. Therefore, it's important to consider other factors, such as sensitivity analysis and scenario
analysis, to assess the risk associated with the investment and its potential impact on the expected NPV.

QN 2

(i) To compute the expected return, variance, and standard deviation, we need to first calculate the
expected rate of return for each stock by taking the weighted average of the possible returns, using the
probabilities as weights. Then, we can calculate the variance and standard deviation as follows:

Expected return for Kay Computer Company:

(-60% x 0.15) + (-30% x 0.10) + (-10% x 0.05) + (20% x 0.40) + (40% x 0.20) + (80% x 0.10) = 20%

Expected return for Gray Disc ltd:

(15% x 0.20) + (10% x 0.05) + (-5% x 0.10) + (20% x 0.25) + (15% x 0.12) + (30% x 0.28) = 17.25%

Variance for Kay Computer Company:

[(−60%−20%)^2 x 0.15] + [(−30%−20%)^2 x 0.10] + [(−10%−20%)^2 x 0.05] + [(20%−20%)^2 x 0.40] +

[(40%−20%)^2 x 0.20] + [(80%−20%)^2 x 0.10] = 0.358
Standard deviation for Kay Computer Company:

√0.358 = 0.599

Variance for Gray Disc ltd:

[(15%-17.25%)^2 x 0.20] + [(10%-17.25%)^2 x 0.05] + [(-5%-17.25%)^2 x 0.10] + [(20%-17.25%)^2 x 0.25]

+ [(15%-17.25%)^2 x 0.12] + [(30%-17.25%)^2 x 0.28] = 0.084

Standard deviation for Gray Disc ltd:

√0.084 = 0.290

(ii) On the basis of expected return alone, Kay Computer is preferable as it has a higher expected return
(20%) compared to Gray Disc (17.25%).

(iii) On the basis of standard deviation alone, Kay Computer is less preferable as it has a higher standard
deviation (0.599) compared to Gray Disc (0.290), indicating that Kay Computer is riskier than Gray Disc.

(iv) The coefficient of variation (CV) is a measure of relative dispersion calculated by dividing the
standard deviation by the mean. We can calculate the CV for each stock as follows:

CV for Kay Computer Company:

0.599 / 0.20 = 2.995

CV for Gray Disc ltd:

0.290 / 0.1725 = 1.681

The stock return series for Kay Computer Company has a greater relative dispersion as it has a higher CV
compared to Gray Disc ltd.

(v) The covariance between the returns for Kay Computer and Gray Disc ltd can be calculated using the
formula:
Covariance = ∑[(rate of return for Kay - expected return for Kay) x (rate of return for Gray - expected
return for Gray) x probability]

Covariance = [(-60%-20%) x (15%-17.25%) x 0.15] + [(-30%-20%) x (10%-17.25%) x 0.10] + [(-10%-20%) x

(-5%-17.25%) x 0.05] + [(20%-20%) x (20%-17.25%) x 0.40] + [(40%-20%) x (15%-17.25%) x 0.20] + [(80%-
20%) x (30%-17.25%) x 0.10] = -0.010

Therefore, the covariance between the returns for Kay Computer and Gray Disc ltd is -0.010.

(vi) The correlation coefficient between the rate of returns of Kay Computer and Gray Disc ltd can be
calculated using the formula:

Correlation coefficient = Covariance / (Standard deviation for Kay Computer x Standard deviation for
Gray Disc ltd)

Correlation coefficient = -0.010 / (0.599 x 0.290) = -0.061

Therefore, the correlation coefficient between the rate of returns of Kay Computer and Gray Disc ltd is -
0.061.

(vii) The coefficient of determination (R-squared) associated with Kay Computer and Gray Disc ltd can be
calculated as the square of the correlation coefficient:

R-squared = (-0.061)^2 = 0.004

Therefore, the coefficient of determination associated with Kay Computer and Gray Disc ltd is 0.004.

(viii) The negative covariance and correlation coefficient suggest that the returns of Kay Computer and
Gray Disc are negatively related, i.e, when one stock is performing well, the other is likely to perform
poorly. The low R-squared value indicates that only a small proportion of the variation in the returns of
Kay Computer and Gray Disc can be explained by their correlation. Overall, these measures suggest that
Kay Computer and Gray Disc have a weak negative relationship and are not highly correlated, which may
make them suitable for diversification in a portfolio.
QN 3

(a) To calculate the Beta of the portfolio, we can use the formula:

Portfolio Beta = ∑(Beta of stock i x Proportion of stock i in portfolio)

Portfolio Beta = (0.9 x 0.35) + (1.1 x 0.45) + (-0.8 x 0.20) = 0.56

The Beta of the investor's portfolio is 0.56. A Beta of less than 1 indicates that the portfolio is less
volatile than the market, while a Beta greater than 1 indicates that the portfolio is more volatile than the
market. In this case, since the portfolio Beta is between 0 and 1, it suggests that the portfolio is less
volatile than the market.

(b) An efficient market is a market where all available information is reflected in the prices of assets. In
other words, in an efficient market, it is impossible to consistently earn excess returns by using publicly
available information. The benefits of an efficient market include increased market transparency,
reduced information asymmetry, and improved allocation of resources.

(c) If the efficient market hypothesis is true, it implies that all available information is already priced into
the assets, and it is impossible to consistently earn excess returns by using publicly available
information. Therefore, investors cannot outperform the market by simply investing in undervalued or
overvalued assets. Instead, they must rely on other strategies such as diversification, asset allocation,
and risk management to achieve their investment goals.

(d) (i) Blue chip stocks are large, established companies that are known for their stability and reliability.
In the Zimbabwean market, examples of blue chip stocks include Delta Corporation, Econet Wireless
Zimbabwe, and Old Mutual Zimbabwe. These stocks are considered blue chip because they have a long
history of stable earnings, strong financials, and a large market capitalization.

(ii) Defensive stocks are stocks that are less affected by changes in the economy and are considered a
safe investment during economic downturns. In the Zimbabwean market, examples of defensive stocks
include National Foods Holdings Limited, Seed Co Limited, and Padenga Holdings Limited. These stocks
are considered defensive because they are less sensitive to economic cycles and have a stable demand
for their products or services.

QN 4
(a) Emotions can influence investors' decision making in various ways, including:

- Fear and panic selling during market downturns, leading to lower prices.

- Greed and FOMO (fear of missing out) leading to buying high and selling low.

- Overconfidence leading to excessive risk-taking and ignoring potential losses.

- Herd mentality leading to following the crowd without proper analysis.

- Confirmation bias leading to seeking information that confirms one's beliefs and ignoring contradictory
information.

(b) Overconfident investors tend to have an unrealistic belief in their ability to predict the market or pick
winning stocks. They may engage in excessive trading, take on more risk than they should, and ignore
diversification principles. They may also be resistant to feedback and tend to attribute their success to
their skill rather than luck.

(c) The profit realized from the option can be calculated as follows:

Profit = (Price of bitcoin at expiration - Strike price) x Number of bitcoins - Option premium

Profit = ($12,500 - $10,000) x 1 - 0.05 BTC = $2,445

Therefore, the profit realized from the option is $2,445.

(d) Option price and option premium are often used interchangeably, but they have different meanings.
Option premium refers to the price that the buyer pays to the seller for the right to buy or sell the
underlying asset at a specific price (strike price) within a specific time frame (expiration date). It is the
cost of buying an option. Option price, on the other hand, refers to the current market value of the
option and is determined by various factors such as the underlying asset price, strike price, time to
expiration, volatility, and interest rates. Option price can be higher or lower than the option premium
depending on the current market conditions and the option's intrinsic value.

QN PAPER 2
QN 1

(a) The overall purpose people have for investing is to increase their wealth over time. This can be
achieved by investing in assets that appreciate in value, such as stocks, real estate, or commodities.
Investing can also provide a source of income through dividends, interest, or rental income. Additionally,
investing can help individuals achieve their long-term financial goals, such as retirement, education, or
buying a house.

(b) The variance of the distribution of expected rates of return is considered a good measure of
uncertainty because it measures the extent to which actual returns may deviate from expected returns.
A higher variance indicates greater uncertainty and higher risk, while a lower variance indicates lower
risk. Financial theorists use this measure of risk to assess the probability of achieving a certain level of
return and to compare the risk of different investments.

(c) An example of a liquid investment is a stock that trades on a major stock exchange. These stocks can
be easily bought or sold at any time during market hours, and the transaction can be completed quickly
at a fair market price. An example of an illiquid investment is a private equity investment in a startup
company. These investments are not traded on a public exchange, and it can be difficult to find a buyer
or seller. The transaction process can be lengthy, and the price may not reflect the true market value.

(d)

(i) Real assets/investments are tangible assets such as real estate, commodities, and natural resources.
In the Zimbabwean context, examples of real assets include farmland, mines, and residential or
commercial properties. These investments provide a hedge against inflation and can appreciate in value
over time.

(ii) Financial assets/investments are intangible assets such as stocks, bonds, and derivatives. In
Zimbabwe, examples of financial assets include shares of listed companies, government bonds, and
futures contracts. These investments provide liquidity, diversification, and the potential for higher
returns but are subject to market volatility and risk.

(iii) Direct investing involves purchasing assets directly, such as buying real estate or a business. In
Zimbabwe, an example of direct investing is buying a piece of land for development. Indirect investing
involves investing in assets through a third party, such as a mutual fund or an exchange-traded fund
(ETF). In Zimbabwe, an example of indirect investing is buying shares of a mutual fund that invests in
local stocks or bonds. Direct investing provides more control over the investment but requires more
effort and expertise, while indirect investing provides diversification and convenience but may have
higher fees and lower control.
GN 2

(a)

i. To determine which fund is optimal to combine with the risk-free security, we need to calculate the
Sharpe ratio for each fund. The Sharpe ratio is calculated as follows:

Sharpe ratio = (Expected return - Risk-free rate) / Standard deviation

For DMF: Sharpe ratio = (20% - 8%) / 14% = 0.857

For OCIG: Sharpe ratio = (12% - 8%) / 11% = 0.364

Therefore, the optimal fund to combine with the risk-free security is DMF, as it has a higher Sharpe
ratio.

ii. To earn a target return of 22%, we can use the following formula to calculate the portfolio weights:

Weight in DMF = (Target return - Risk-free rate) x Standard deviation of OCIG / (Expected return of DMF
- Expected return of OCIG)

Weight in Risk-free security = 1 - Weight in DMF

Weight in DMF = (22% - 8%) x 11% / (20% - 12%) = 0.825

Weight in Risk-free security = 1 - 0.825 = 0.175

Therefore, to earn a target return of 22%, Samaita should invest 82.5% of his portfolio in DMF and 17.5%
in the risk-free security.
iii. To calculate Samaita's return and standard deviation if he had invested 60% in DMF and 40% in OCIG,
we can use the following formula:

Portfolio expected return = Weight in DMF x Expected return of DMF + Weight in OCIG x Expected
return of OCIG + Risk-free rate

Portfolio expected return = (0.6 x 20%) + (0.4 x 12%) + 8% = 16.4%

Portfolio standard deviation = sqrt((Weight in DMF^2 x Variance of DMF) + (Weight in OCIG^2 x Variance
of OCIG) + 2 x Weight in DMF x Weight in OCIG x Covariance of DMF and OCIG)

Portfolio standard deviation = sqrt(((0.6^2) x 0.08) + ((0.4^2) x 0.05) + (2 x 0.6 x 0.4 x 0.00154)) = 0.1608
or 16.08%

Therefore, if Samaita had invested 60% in DMF and 40% in OCIG, his return over the last year would
have been 16.4% and his standard deviation would have been 16.08%.

(b)

i. The betas of the five investments can be calculated using the CAPM formula:

Beta = Covariance with the market / Variance of the market

For M: Beta = 1

For RF: Beta = 0

For X: Beta = 0.2

For Y: Beta = 0.4

For Z: Beta = 0.6

ii. The Capital Market Line (CML) and the Security Market Line (SML) can be drawn using the following
formula:
CML: Expected return = Risk-free rate + Sharpe ratio x Standard deviation of the portfolio

SML: Expected return = Risk-free rate + Beta x (Expected return of the market - Risk-free rate)

M represents the market portfolio, and RF is the risk-free security. X, Y, and Z are individual securities.

The CML is a straight line that starts at the risk-free rate and has a slope equal to the Sharpe ratio of the
market portfolio. The SML is also a straight line that starts at the risk-free rate and has a slope equal to
the expected return of the market minus the risk-free rate, multiplied by the beta of the security.

The location of M, RF, X, Y, and Z are shown on the graph below:


iii. False. Even though Y and Z have the same standard deviation, they may have different betas, and
hence, different levels of systematic risk. Therefore, they may not be equally risky.

(a)

i. To determine which fund is optimal to combine with the risk-free security, we need to calculate the
Sharpe ratio for each fund. The Sharpe ratio is calculated as follows:

Sharpe ratio = (Expected return - Risk-free rate) / Standard deviation

For DMF: Sharpe ratio = (20% - 8%) / 14% = 0.857

For OCIG: Sharpe ratio = (12% - 8%) / 11% = 0.364

Therefore, the optimal fund to combine with the risk-free security is DMF, as it has a higher Sharpe
ratio.

ii. To earn a target return of 22%, we can use the following formula to calculate the portfolio weights:
Weight in DMF = (Target return - Risk-free rate) x Standard deviation of OCIG / (Expected return of DMF
- Expected return of OCIG)

Weight in Risk-free security = 1 - Weight in DMF

Weight in DMF = (22% - 8%) x 11% / (20% - 12%) = 0.825

Weight in Risk-free security = 1 - 0.825 = 0.175

Therefore, to earn a target return of 22%, Samaita should invest 82.5% of his portfolio in DMF and 17.5%
in the risk-free security.

iii. To calculate Samaita's return and standard deviation if he had invested 60% in DMF and 40% in OCIG,
we can use the following formula:

Portfolio expected return = Weight in DMF x Expected return of DMF + Weight in OCIG x Expected
return of OCIG + Risk-free rate

Portfolio expected return = (0.6 x 20%) + (0.4 x 12%) + 8% = 16.4%

Portfolio standard deviation = sqrt((Weight in DMF^2 x Variance of DMF) + (Weight in OCIG^2 x Variance
of OCIG) + 2 x Weight in DMF x Weight in OCIG x Covariance of DMF and OCIG)

Portfolio standard deviation = sqrt(((0.6^2) x 0.08) + ((0.4^2) x 0.05) + (2 x 0.6 x 0.4 x 0.00154)) = 0.1608
or 16.08%

Therefore, if Samaita had invested 60% in DMF and 40% in OCIG, his return over the last year would
have been 16.4% and his standard deviation would have been 16.08%.

(b)

i. The betas of the five investments can be calculated using the CAPM formula:
Beta = Covariance with the market / Variance of the market

For M: Beta = 1

For RF: Beta = 0

For X: Beta = 0.2

For Y: Beta = 0.4

For Z: Beta = 0.6

ii. The Capital Market Line (CML) and the Security Market Line (SML) can be drawn using the following
formula:

CML: Expected return = Risk-free rate + Sharpe ratio x Standard deviation of the portfolio

SML: Expected return = Risk-free rate + Beta x (Expected return of the market - Risk-free rate)

M represents the market portfolio, and RF is the risk-free security. X, Y, and Z are individual securities.

The CML is a straight line that starts at the risk-free rate and has a slope equal to the Sharpe ratio of the
market portfolio. The SML is also a straight line that starts at the risk-free rate and has a slope equal to
the expected return of the market minus the risk-free rate, multiplied by the beta of the security.

The location of M, RF, X, Y, and Z are shown on the graph below:


iii. False. Even though Y and Z have the same standard deviation, they may have different betas, and
hence, different levels of systematic risk. Therefore, they may not be equally risky.

(c) The coefficient of variation (CV) is calculated as the ratio of the standard deviation to the expected
return. It is used to measure the risk-adjusted return of an investment.
CV = Standard deviation / Expected return

For asset A: CV = 0.5333

For asset B: CV = 0.25

Asset B has a lower coefficient of variation, which means it has a higher risk-adjusted return compared
to asset A. Therefore, based on the coefficient of variation, asset B would be the better choice.

QN 3

(a) Cryptocurrencies have several functions beyond just being a method for payment. These include:

1. Store of value: Cryptocurrencies can be used as a store of value, much like traditional currencies or
gold. Some investors purchase cryptocurrencies as a hedge against inflation or to diversify their
investment portfolio.

2. Decentralized transactions: Cryptocurrencies allow for decentralized transactions, meaning that they
can be exchanged without the need for intermediaries like banks or financial institutions. This can make
transactions faster, cheaper, and more secure.

3. Smart contracts: Some cryptocurrencies, like Ethereum, allow for the creation of smart contracts
which can execute automatically when certain conditions are met. This can be useful for a variety of
applications, such as supply chain management or real estate transactions.

4. Fundraising: Cryptocurrencies can be used to raise funds for new projects or ventures through initial
coin offerings (ICOs) or other crowdfunding mechanisms.

(b) Cryptocurrency transactions are recorded on a public ledger called a blockchain. Each transaction is
verified by a network of computers, and once verified, it is added to the blockchain. The blockchain is a
decentralized ledger, meaning that it is distributed across a network of computers and is not controlled
by any single entity. This makes the transactions more secure, transparent, and resistant to fraud or
hacking.
(c) While cryptocurrencies can be used for illicit activities, it is important to note that the vast majority
of cryptocurrency transactions are legitimate. Cryptocurrencies have gained a reputation for being used
in illegal activities because they can be used to make anonymous transactions. However, it is also
important to note that traditional currencies are also used for illegal activities. The use of
cryptocurrencies for illegal activities is a concern, but it is not unique to cryptocurrencies and should not
be used as a reason to dismiss their potential benefits.

(d) The portfolios of overconfident investors have a higher risk for several reasons. Overconfident
investors tend to take on more risk than they can handle, leading to higher levels of volatility in their
portfolios. They may also be more likely to engage in speculative investments or to trade more
frequently, which can increase transaction costs and reduce returns. Additionally, overconfident
investors may be more likely to engage in information asymmetry, meaning they may believe they have
more information or insight than the market as a whole, leading to suboptimal investment decisions.

(e) Emotions can have a significant impact on investors' decision making. For example:

1. Fear and panic: During market downturns, fear and panic can lead investors to sell their investments
at a loss, rather than holding onto them and waiting for the market to recover.

2. Greed and overconfidence: These emotions can lead investors to take on too much risk or to make
speculative investments that may not be in their best interest.

3. Anchoring bias: This occurs when investors cling to a particular price point or benchmark, even if it is
not relevant to the current market conditions.

4. Confirmation bias: This occurs when investors seek out information that confirms their existing
beliefs, rather than considering alternative viewpoints.

Overall, emotions can cloud investors' judgment and lead to suboptimal investment decisions. It is
important for investors to remain disciplined and rational, and to avoid making decisions based solely on
emotions.

QN 4
(a) Defensive stocks are typically those that are less affected by changes in the economy and tend to
perform well even during economic downturns. Examples of defensive stocks in the domestic market of
many countries may include companies that produce or sell consumer staples such as food, beverages,
and household goods. Some examples of defensive stocks in the domestic market of the United States,
for instance, include Walmart, Procter & Gamble, and Coca-Cola.

(b) Blue-chip stocks are typically considered to be high-quality, well-established companies with a long
track record of stable earnings and growth potential. Some examples of blue-chip stocks in the domestic
market of the United States include Apple, Microsoft, and Johnson & Johnson. These companies are
categorized as blue chips because they have a strong reputation, a long history of stable performance,
and are generally considered to be relatively safe investments.

(c) In this situation, the trader has purchased a call option with a strike price of $25 for a premium of
$150. On the expiration date, the stock is selling for $35, which means that the option has an intrinsic
value of $10 per share ($35 - $25 = $10). Since the option is for 100 shares, the trader's profit is:

Profit = (Intrinsic value of the option - Premium paid) x Number of shares

Profit = ($10 - $1.50) x 100 = $850

Therefore, the trader has made a profit of $850 from the option.

QN PAPER 3

QN 1

(a) Direct investing refers to investing directly in securities, such as stocks or bonds, without the use of
intermediaries. For example, an individual might purchase shares of stock in a company directly from
the stock market or invest in a bond issued by a corporation. On the other hand, indirect investing refers
to investing in securities through intermediaries, such as mutual funds or exchange-traded funds (ETFs).
For example, an individual might invest in a mutual fund that holds a diversified portfolio of stocks or
bonds. The main difference between direct and indirect investing is that direct investing requires more
research and knowledge about individual securities, while indirect investing allows for diversification
and professional management.

(b)

i) The investment objectives could be capital growth, income, or a combination of both.

ii) The amount of funds that can be invested for a 3-year period depends on the individual's financial
situation, risk tolerance, and investment objectives.

iii) The investment vehicles that could be used for investment include stocks, bonds, mutual funds, ETFs,
real estate, and alternative investments such as private equity or hedge funds.

iv) The type of investment vehicles that would be relevant depends on the individual's investment
objectives, risk tolerance, and financial situation. For example, if the investment objective is capital
growth and the investor has a higher risk tolerance, they may consider investing in stocks or mutual
funds that invest in growth stocks. If the investor has a lower risk tolerance, they may consider investing
in bonds or bond funds.

v) The critical factors for investment decision making in a particular investment environment include the
economic and political environment, inflation, interest rates, tax laws, and market conditions.

(c) During the early years, a person in their 20s is likely to save more than they borrow as they start their
career and begin to build their savings. In their 40s, they are likely to save for retirement and may
borrow for large purchases such as a home or children's education. By the time a person reaches their
55s, they are likely to have paid off most of their debt and be focused on retirement savings.

(d) The Holding Period Return (HPR) can be calculated as follows:

HPR = (Ending price - Beginning price + Dividends) / Beginning price

HPR = ($39 - $34 + $1.50) / $34

HPR = 21.47%
The Holding Period Yield (HPY) can be calculated as follows:

HPY = (Ending price + Dividends - Beginning price) / Beginning price

HPY = ($39 + $1.50 - $34) / $34

HPY = 23.53%

QN 2

(a) Methods and tools of statistics are important in investment decision making because they provide a
framework for analyzing and interpreting financial data. By using statistical methods, investors can
identify patterns and trends in the data, measure the potential risks and returns of different
investments, and make more informed decisions. Statistics can also help investors to understand the
relationships between different variables, such as the relationship between a stock's price and its
earnings, or the relationship between a company's financial performance and its share price.

(b)

(i) The expected return of stock A can be calculated by taking the average of the rates of return:

Expected return of stock A = (35% + 20% - 6% + 12% + 7% + 10%) / 6 = 14.67%

The expected return of the market portfolio can be calculated in the same way:

Expected return of the market portfolio = (13% + 8% - 10% - 4% + 12% + 7%) / 6 = 5.33%

(ii) The standard deviation of stock A can be calculated using the formula:

Standard deviation of stock A = SQRT[(sum of (rate of return - expected return)^2) / (number of

observations - 1)]
Standard deviation of stock A = SQRT[((35% - 14.67%)^2 + (20% - 14.67%)^2 + (-6% - 14.67%)^2 + (12% -
14.67%)^2 + (7% - 14.67%)^2 + (10% - 14.67%)^2) / (6 - 1)]

Standard deviation of stock A = 17.57%

The standard deviation of the market portfolio can be calculated in the same way:

Standard deviation of the market portfolio = 7.72%

(iii) The covariance between the rate of return for stock A and the market portfolio can be calculated
using the formula:

Covariance = (sum of (rate of return for stock A - expected return for stock A) x (rate of return for the
market portfolio - expected return for the market portfolio)) / (number of observations - 1)

Covariance = ((35% - 14.67%) x (13% - 5.33%) + (20% - 14.67%) x (8% - 5.33%) + (-6% - 14.67%) x (-10% -
5.33%) + (12% - 14.67%) x (-4% - 5.33%) + (7% - 14.67%) x (12% - 5.33%) + (10% - 14.67%) x (7% - 5.33%))
/ (6 - 1)

Covariance = 73.67

(iv) The beta factor of stock A can be calculated using the formula:

Beta = Covariance / Variance of the market portfolio

Variance of the market portfolio = (sum of (rate of return for the market portfolio - expected return for
the market portfolio)^2) / (number of observations - 1)

Variance of the market portfolio = ((13% - 5.33%)^2 + (8% - 5.33%)^2 + (-10% - 5.33%)^2 + (-4% -
5.33%)^2 + (12% - 5.33%)^2 + (7% - 5.33%)^2) / (6 - 1)
Variance of the market portfolio = 0.070

Beta = 73.67 / 0.070 = 1052.43

The beta factor of stock A is very high, indicating that the stock is highly sensitive to market movements.

(v) The correlation coefficient between the rates of return of stock A and the market portfolio can be
calculated using the formula:

Correlation coefficient = Covariance / (Standard deviation of stock A x Standard deviation of the market
portfolio)

Correlation coefficient = 73.67 / (17.57% x 7.72%)

Correlation coefficient = 1.13

The correlation coefficient is positive and greater than 1, which indicates that there is a very strong
positive relationship between the rates of return of stock A and the market portfolio.

(vi) The coefficient of determination associated with stock A and the market portfolio is equal to the
square of the correlation coefficient, which is 1.27. This indicates that 127% of the variance in the rate of
return for stock A can be explained by the variance in the rate of return for the market portfolio.

(vii) The characteristic line of stock A can be plotted using the data in the table. The line will show the
relationship between the rate of return for stock A and the rate of return for the market portfolio. The
slope of the line represents the beta factor, while the intercept represents theexpected return of stock A
when the market portfolio has a rate of return of zero. The characteristic line can help investors to
understand how stock A is likely to perform in different market conditions. For example, if the market
portfolio has a high rate of return, the characteristic line would suggest that stock A is likely to have a
higher rate of return as well. On the other hand, if the market portfolio has a low rate of return, stock A
is likely to have a lower rate of return as well.
(viii) Based on the high beta factor and strong positive correlation with the market portfolio, stock A may
not be suitable for an investor with a lower tolerance for risk. This is because the stock is highly sensitive
to market movements and could experience significant fluctuations in value. Investors with a lower
tolerance for risk may prefer to invest in stocks with lower beta factors and less sensitivity to market
movements.

QN 3

(a) A minimum variance portfolio is a portfolio of assets that is optimized to minimize the portfolio's
variance, or risk, for a given level of expected return. The efficient frontier is a graph that shows the
tradeoff between expected return and risk for a set of portfolios. The minimum variance portfolio is the
point on the efficient frontier with the lowest level of variance, or risk, for a given level of expected
return. It is the portfolio that offers the greatest diversification benefits for a given level of expected
return.

(b) Beta is a measure of the systematic risk of a stock, or the risk that cannot be diversified away. A beta
of 1 indicates that the stock's returns are perfectly correlated with the market, while a beta greater than
1 indicates that the stock is more sensitive to market movements, and a beta less than 1 indicates that
the stock is less sensitive to market movements.

Based on the beta values presented, stocks B and E are more risky than the others, with betas of 2.20
and 1.18, respectively. These stocks are more sensitive to market movements and have the potential for
larger fluctuations in value. Stocks A, C, and F have lower betas and are therefore less risky. Stock D has
a negative beta, which means that its returns are negatively correlated with the market. This stock is not
necessarily less risky, but it has a different risk profile than the other stocks presented.

(c) Blue chip stocks are typically large, well-established companies that are leaders in their industry and
have a history of stable earnings and dividend payments. Examples of blue chip stocks in the domestic
market may include companies such as Microsoft, Apple, Coca-Cola, and Procter & Gamble. These
companies are considered blue chips because they have a strong financial position, a long track record
of success, and are typically considered safer investments than smaller or more volatile companies.

(d)

a) The intrinsic value of the bond can be estimated using the formula:

PV = (C / r) x (1 - 1 / (1 + r)^n) + F / (1 + r)^n
where PV is the present value of the bond, C is the annual coupon payment, r is the discount rate, n is
the number of years to maturity, and F is the face value of the bond. Plugging in the values given,

PV = (70 / 0.1) x (1 - 1 / 1.1^4) + 1000 / 1.1^4

PV = $876.97

The intrinsic value of the bond is slightly higher than the current market price of $875, which suggests
that the bond may be undervalued. Migel may consider purchasing the bond if he believes that the
bond's price will increase over time.

b) The yield-to-maturity of the bond can be estimated by solving for the discount rate that equates the
present value of the bond's future cash flows to its current price. Using the formula above, we can solve
for the discount rate that makes the present value of the bond equal to its current price of $875:

$875 = (70 / r) x (1 - 1 / (1 + r)^4) + 1000 / (1 + r)^4

Solving for r using numerical methods, we find that the yield-to-maturity of the bond is approximately
9.02%. Migel may consider purchasing the bond if he believes that the yield-to-maturity is attractive
compared to other investments with similar risk profiles.

QN 4

(a) The "snakebite effect" is a behavioral bias that can influence investors' behavior. It refers to the
tendency of an investor to become overly cautious and risk-averse after experiencing a significant loss in
the market. Examples of how the snakebite effect can influence investors' behavior include:

- Selling off all or most of their investments after a market downturn, even if the investments are high-
quality and have strong long-term prospects.

- Avoiding certain types of investments or asset classes altogether, such as stocks or emerging markets,
due to a fear of losing money.

- Focusing too much on short-term performance and making investment decisions based on recent
market trends, rather than taking a long-term view.

- Holding on to cash or other "safe" assets for too long, missing out on potential gains from higher-risk
investments.
(b)

- The call option with an exercise price of 18 is in the money, as the current price of the underlying stock
(19.50) is higher than the exercise price.

- The put option with an exercise price of 30 is out of the money, as the current price of the underlying
stock (31.20) is higher than the exercise price.

To determine whether an option is at the money, we would need to know the current price of the
underlying stock relative to the exercise price. Without this information, we cannot determine whether
the call option is at the money.

(c)

- For the call option, if it is exercised, the investor would pay $18 per share to buy the stock, and could
then sell it at the current market price of $19.50, making a profit of $1.50 per share. However, since the
option premium was paid upfront, the net profit would be $1.25 per share ($1.50 profit - $0.25
premium).

- For the put option, if it is exercised, the investor would sell the stock at the exercise price of $30 per
share, which is higher than the current market price of $31.20 per share. Therefore, exercising the put
option would result in a loss of $1.20 per share. However, since the option premium was paid upfront,
the net loss would be $0.70 per share ($1.20 loss + $0.50 premium).