In: Finance
1. Frane Ltd has available two investment opportunities with the
following risk return
characteristics
A | B | |
Expected return | 13% | 20% |
Risk | 4% | 8% |
Frane Ltd plans to invest 65% of its available funds in Security
A, and 35% in B.
The directors believe that the correlation coefficient between the
returns of the
securities is +0.2.
(i) Calculate the expected return of the portfolio and the risk of the portfolio.
E(RP)=15.45%
σp= 4.18%
This one I have calculated, thank you.
(ii) Suppose the correlation coefficient between A and B was -1.0.
How should Frane
Ltd invest its funds in order to obtain a zero risk portfolio?
by using ( a – b )² = a²-2ab+b²
I have tried, but also don't know how to do. Thank you.
σp² = (xσA)² + [(1-x) σB]² + 2x(1-x) ρAB σAσB
= (0.65 x 0.04)² + (0.35 x 0.08)² + 2(0.65)(0.35)(-0.1)(0.04)(0.08)?
(iii) According to CAPM, “The only risk that matters to an investor
is
non-diversifiable risk.” Do you agree with the comment?
2. “Both trade-off theory and pecking order theory explain why
companies may differ
in their levels of gearing.” Discuss this statement.
Like the answer or comment in case you need any
clarifications.