The table below provides the share return forecasts and associated probabilities

Question

The table below provides the share return forecasts and associated probabilities for Western Innovations Limited (WIL) and Albright Limited (ABL). The share return performance for the companies depends to a great extent on future economic conditions.

WIL

ABL

a. Calculate the expected return on each share (4 marks).

b. Calculate the variance and standard deviation for each share (4 marks).

c. Assuming a correlation coefficient of -0.5 between the returns from the two shares, calculate the expected return and the standard deviation of the following investment allocation strategies:

i. Investing 50% of available funds into WIL and the remaining 50% into ABL (2 marks).

ii. Investing 75% of the available funds into WIL and the remaining 25% into ABL (2 marks).

iii. Assuming no other investment opportunities exist, which of the two strategies would be preferred by a highly risk averse investor? Discuss your recommendation (3 marks).

Explanation / Answer

Ans 1 (a) WLL Return Probability Expected Return 20% 0.4 8% 12% 0.2 2% 5% 0.4 2% 12% Ans 1 (b) ABL Return Probability Expected Return 20.30% 0.2 4% 10.50% 0.5 5% 7% 0.3 2% 11% Ans 2(a) WLL Return Probability Expected Return Deviation Variance= Deviation^2*Probability 20% 0.4 12% 8% 0.231% 12% 0.2 12% 0% 0.000% 5% 0.4 12% -7% 0.219% 0.450% Std Deviation=Square root of Variance 6.71% Ans 2(b) ABL Return Probability Expected Return Deviation Variance= Deviation^2*Probability 20.30% 0.2 11% 9% 0.158% 10.50% 0.5 11% -1% 0.004% 7% 0.3 11% -4% 0.058% 0.221% Std Deviation=Square root of Variance 4.70%

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