Question

i)        Provide an intuitive discussion of beta and its importance for measuring risk.

ii)       Consider the following probability distribution of returns for Mason Corporation:

Current Stock Price (Ghc)	n	Price in One Year (Ghc)	n	Return	n	Probability
		Ghc35		40%		25%
Ghc25		Ghc25		0%		50%
		Ghc20		-20%		25%

You are required to compute the expected return and standard deviation of return on Mason Corporation.

2. Security A has an expected rate of return of 22% and a beta of 2.5. Security B has a beta of 1.20. If the Treasury bill rate is 10%, what is the expected rate of return for security B?

1. What is the benefit to diversification? Will diversification always lead to greater expected portfolio returns?

2. Your company purchased Uptown Records stock for Ghc14.65 and sold it 6 months later for Ghc17.38 after receiving a Ghc0.25 dividend. What was your company's holding period return (HPR); what was your Annual Percentage Rate (APR); and what was your Effective Annual Rate (EAR)?

Answer 1

Answer 1.

Beta is a measure of voltatality in the stock vis a vis market. The volatality is also known as risk. The CAPM model assumes that any portfolio well diversified will have only systematic risk which can be measured by Beta. Higher the value of Beta, higher will be the systematic risk an therfore higher will be the required return.

Answer 2 Return = 5% and Standard deviation = 21.79%

Return and Standard Deviation of a Security with given Probability

Expected Return = ∑(Ret * Probability)

Standard Deviation =

Where Pi = Probability

Ret = Return of the stock

Ret Expected = Expected Return

ANswer 3

As per CAPM, Expected return = Risk free return + beta* (market premiuim)

For Sec A 22 = 10 + 2.5* Mraket Premium => Market Premium = 4.8 %

For security B = 10 + 1.2*4.8 = 15.76%

ANswer 4

Portfolio Diversification means putting the investemnets into various class of assets or shares so that a fall in price of one may well be compensated by a rise in the other. The basic objective of the diversification is to minimise the total risk, so that the return can be optimised. However diversification reduces the chances of risk, it can't be said that diversification always lead to higher profit.