Calculate the means and standard deviations of the returns of each of the four companies over the period

INSTRUCTIONS TO CANDIDATES

ANSWER ALL QUESTIONS

(a) Calculate the means and standard deviations of the returns of each of the four              

companies over the period. Do the risk-return patterns for these companies correspond with your prior expectations? Why or why not?

 

(b) Assume that you have $1m to invest. Construct 3 alternative portfolios as follows:    

     Portfolio 1: 50% in a company in the safe industry and 50% in a company in the risky

      industry. Portfolio 2:  50% in each of the 2 companies in the safe industry. Portfolio

      3: 50% in each of the 2 companies in the risky industry.  Calculate the sample

      correlation coefficient between the two companies in each of the 3 portfolios,

      comment on the size and interpretation of these correlations. For each of the 3

      portfolios calculate the means and standard deviations of the returns over the period.

      Are there any surprises ?

 

c) Distinguish between specific and market risk. Which of the 3 alternative portfolio

    diversifications would have been most justifiable in terms of reducing the specific risk     

    of investment?    

 

(d) Using regression analysis estimate the CAPM equation Rpi = Rf +Bpi (Rm-Rf)+ Ei 

      for each of the 3 portfolios. Interpret the meaning of the Bpi value in each of the 3

      portfolios. Are there any surprises ?

(e) For portfolio 1, compare the R2 from the portfolio regression in part (d) with the R2

     values from separate CAPM equation estimations for the 2 companies within portfolio

1.      Would you expect the R2 from the portfolio equations to be higher than that from

 

the two individual equations? Why or why not?

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