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Question 1 (20 Marks) Risk & Return [CLO 4]

  1. Security A has

an expected return of 7%, a standard deviation of expected returns of 35%, a correlation coefficient with the market of -0.3, and a beta coefficient of -0.5. Security B has an expected return of 12%, a standard deviation of returns of 10%, a correlation coefficient with the market of 0.7, and a beta coefficient of 1.0.

In a single=asset portfolio, Which security is riskier? Why?  (2 Marks)

  1. Stocks A has the following historical returns reported in the sample below:

                 Year                        Stock A (KA)

                           2002                             (10%)          

                          2003                              18.50%       

                          2004                              38.67%        

                         2005                              14.33%         

        2006                              33.00%          

          

b) What is the Risk per unit return of Stock A     (7 Marks)

  1. ERCI Corporation is a holding company with four main subsidiaries. The percentage of its business coming from each of the subsidiaries, and their respective betas are as follows: (ST-3)

                        SUBSIDIARY                  % OF BUSINESS               BETA____

               Electric Utility                               60%                               0.70

              Cable Company                              25%                               0.90

               Real Estate                                     10%                               1.30

               International/Special Projects         5%                               1.50

         ---------------------------------------------------------------------------------------

Assume that the risk free rate is 6% and the market premium is 5%. What is the holding company's required rate of return?  (7 marks)

  1. If the Treasury bill rate on a Security A is 7% and the return on the market is 10%, the expected Return is 15%; and the  security's beta is 0.8. What is the recommended trading Strategy for this Security?                    (4 marks)


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