1. The stock of a technology company has an expected return of 15% and a standar
ID: 2648187 • Letter: 1
Question
1.
The stock of a technology company has an expected return of 15% and a standard deviation of 20% The stock of a pharmaceutical company has an expected return of 13% and a standard deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected
return of 14 % and a standard deviation
A) greater than the average of 20% and 18%.
B) the answer cannot be determined with the information given.
C) the average of 20% and 18%.
D) less than the average of 20% and 18%.
2.
You have gathered the following information concerning a particular investment and conditions in the market. Risk-free rate: 2.5%, Market return: 11.0%, Beta of investment: 1.35.
According to the Capital Asset Pricing Model, the required return for this investment is
A) 13.98%. B) 11.48%. C) 14.85%. D) 8.85%.
3?T/F) Adding stocks with higher standard deviations to a portfolio will necessarily increase the portfolio's risk.
4 (T/F) Modern portfolio theory seeks to minimize risk and maximize return by combining highly correlated assets.
Explanation / Answer
SOLUTION:
2. Calculation of Required return for the investment.
ra = rrf + Ba (rm-rrf)
ra = 0.025 + 1.35 (0.11 - 0.025)
ra = 0.025 + 0.11475
ra = 0.13975 or 13.98
Required return for the investment = a) 13.98%
3. True.
The standard deviation measures the fluctuations of the returns around the arithmetic average return of a investment. The higher the standard deviation the greater the variability or risk of the investments returns.
4. True.
The approach helps to maximize the portfolio expected return to a given amount of portfolio risk. Or it equivalent to minimizes the risk for a given level of expected return by carefully choosing the proportions of various assets.
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