Question

1. Calculate the standard deviation of a portfolio consisting of 40 percent stock P and 60 percent stock Q.

Company	Beta	Expected Return	Variance	Correlation Coefficient
P	1.3	28%	0.30	CORRP,Q = 0.3
Q	2.6	12%	0.16

Round to the nearset hundredth percent. Answer in the percent format. Do not include % sign in your answer (i.e. If your answer is 4.33%, type 4.33 without a % sign at the end.)

2.

What is the beta of the following portfolio?

Stock	Beta	Investment
A	1.2	$50,000
B	0.7	$80,000
C	0.5	$30,000
D	1.4	$40,000

Round to the second decimal place.

3.

Which of the following is NOT an example of factors that affect systematic risk?

A change in tax rate Business cycle changes A company's labor force goes on strike An unexpected change in interest rates None of the above

4.

You are analyzing a common stock with a beta of 1.5. The risk-free rate of interest is 5 percent and the expected return on the market is 15 percent. If the stock's return based on its market price is 21.5%,

the stock is overvalued since the expected return is above the SML. the stock is undervalued since the expected return is above the SML. the stock is correctly valued since the expected return is above the SML. the stock is overvalued since the expected return is below the SML. the stock is undervalued since the expected return is below the SML.

Answer 1

Question 1: Standard deviation of portfolio

standard deviation of portfolio is measured by using the formula:

Now, standard deviation is square root of variance. So,

Standard deviation of portfolio = 37.03%

Question 2:

Beta of portfolio is weighted average of the beta of constituents.

Beta of portfolio = (50,000/2,00,000) * 1.2 + (80,000/2,00,000) * 0.7 + (30,000/2,00,000) * 0.5 + (40,000/2,00,000) * 1.4

Beta of portfolio = 0.30 + 0.28 + 0.075 + 0.28 = 0.935

Beta of portfolio = 0.94

Question 3:

Systematic risk is market risk, which impacts all the stocks of market uniformly. Out of all the options given, one risk - company's labor force goes on strike will impact only the particular company in discussion and hence this is the answer.

Question 4:

Based on CAPM,

Required return on stock = Risk free rate + Beta * (Expected market return - Risk free rate)

Required return on stock = 5% + 1.5 * (15% - 5%) = 20%

So, the stock's return based on CAPM is 20% --> on SML. Return based on current market price is 21.5%.

Since expected return (21.5%) is above the SML (20%), it is considered undervalued because the position on the chart indicates that the security offers a greater return against its inherent risk. OPTION 2