Question

a) “The standard deviation of a portfolio's return cannot be reduced to zero by holding all the securities in the market.” True or false? Explain. (2 mark)

An investor buys 1 share of ABC Ltd at the price of $32 on December 1, 2019. The firm is not expected to pay any dividends. Consider the following three possible scenarios for the share price on December 1, 2020:

• $50 with a probability of 30%
• $35 with a probability of 60%
• $23 with a probability of 10%

b) Calculate the expected return for holding the share for a year. (2 mark)

c) Calculate the variance of return and standard deviation of return.

d) On December 1, 2020, the share is worth $36 and the investor just received a dividend of $2.50. Calculate the total holding period return and capital gains return over the one-year period.

e) Explain the difference between expected return and realised return.

Answer 1

PART 1 True, by creating an portfolio only Unsystematic risk got reduced systematic risk is still there in the portfolio. Therefore Standard deviation (Risk) of the portfoli can not be reduced to 0. Sysystematic Risk are realted to a particular company or stock Eg Business Risk, Financial Risk Unsystematic risk are related to whole market. Eg Interest Rate risk , Market Risk.

PART 2 & 3

Part D HPR = [ Income + (End Value – Initial Value)] / Initial Value = [ 2.5 + (36 – 32) ] / 32 = 20.3125% Capital gain return : (End Value – Initial Value) / Initial Value = (36 - 32) / 32 = 12.5%

Part E Expected Return: Before making any Investment, Investor expects some amount of return into consideration of its initial investment. The expected return is consist of all such expectation. It can be calculated by using some models like the capital asset pricing model. The expected return is an assumption that might be based on some Probabilities and might not get realized. Realized return: It is a return actually achieved after buying an asset. Realized return is an actual return and not known at the time of purchasing an asset.