assignment 3

# assignment 3 - The Hong Kong Polytechnic University...

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The Hong Kong Polytechnic University Department of Applied Mathematics Semester 2, 2009/2010 Assignment Three Hand in solutions to questions 1, 2, 3, 4, 5 and 6 by 6:30pm, 30 March. This is worth 2.5% towards your final course mark. Late submissions may not be marked, and if marked will receive reduced or zero credit. 1. In Simpleland there are only two risk stocks A and B, whose details are listed below. Number of shares Price Expected Standard deviation outstanding per share rate of return of return Stock A 200 \$2 . 50 20% 10% Stock B 350 \$3 . 00 17% 8% Furthermore, the correlation coefficient between the returns of stocks A and B is ρ AB = 1 3 . There is also a risk-free asset, and Simpleland satisfies the CAPM exactly. (a) What is the expected rate of return of the market portfolio? (b) What is the standard deviation of the market portfolio? (c) What is the beta of stock A? (d) What is the risk-free rate in Simpleland? 2. Election Wizards, Inc. (EWI) has a new idea for producing TV sets, and it is planning to enter the development stage. Once the product is developed (which will be at the end of 1 year), the company expects to sell its new process for a price p , with expected value ¯ p = \$22 M . However, this sale price will depend on the market for TV sets at the time.

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