Q1)

a) Here we are making portfolio combination in increase of 20% weight in V and

decrease the same in W. We can make other combination also.
Further Return of portfolio = R(V) * Wv + R(W) * Ww
Risk of portfolio
= ((SD V * Wv)2 + (SD W * Ww)2 + 2* SD V*SD W * Ww*Ww*r(v,w))

Calculatio
n of return
an risk of
portfolio

Portfolio Wv WW R(V) R(W) R(P) SD SD Corelatio SD(P)

V W n

a. 0 1 6 10 10.00 5.00 15.00 1.00 15.000

b. 0.2 0.8 6 10 9.20 5.00 15.00 1.00 13.000

c. 0.4 0.6 6 10 8.40 5.00 15.00 1.00 11.000

d. 0.6 0.4 6 10 7.60 5.00 15.00 1.00 9.000

f. 0.8 0.2 6 10 6.80 3.00 15.00 1.00 7.000

h. 1 0 6 10 6.00 5.00 15.00 1.00 5.000

b) If corelation is 0

Calculatio
n of return
an risk of
portfolio

Portfolio Wv WW R(V) R(W) R(P) SD SD Corelatio SD(P)

V W n

a. 0 1 6 10 10.00 5.00 15.00 0.00 15.000

 b. 0.2 0.5 6 10 9.20 5.00 15.00 0.00 12.042

c. 0.4 0.6 6 10 8.40 5.00 15.00 0.00 9.220

d. 0.6 0.4 6 10 7.60 5.00 15.00 0.00 6.708

f. 0.8 0.2 6 10 6.80 5.00 15.00 0.00 5.000

h. 1 0 6 10 6.00 5.00 15.00 0.00 5.000

c) If coleration is -1

Calculatio
n of return
an risk of
portfolio

Portfolio Wv WW R(V) R(W) R(P) SD SD Corelatio SD(P)

V W n

a. 0 1 6 10 10.00 5.00 15.00 -1.00 15.000

b. 0.2 0.8 6 10 9.20 5.00 15.00 -1.00 11.000

c. 0.4 0.6 6 10 8.40 5.00 15.00 -1.00 7.000

d. 0.6 0.4 6 10 7.60 5.00 15.00 -1.00 3.000

f. 0.8 0.2 6 10 6.80 5.00 15.00 -1.00 1.000

h. 1 0 6 10 6.00 5.00 15.00 -1.00 5.000

Q2)

a. Draw the characteristic lines for investments A and B on the same graph.
 Stock A returns
20%

15%
f(x) = 0.734579439252337 x + 0.00659813084112149
10%

5%

0%
-15% -10% -5% 0% 5% 10% 15% 20% 25%
-5%

-10%

-15%

Stock B returns
20%

15%
f(x) = 0.6398753894081 x + 0.0178068535825545
10%

5%

0%
-15% -10% -5% 0% 5% 10% 15% 20% 25%
-5%

-10%

-15%

b. investment A:
y= 0.7346x + 0.0066 (the beta is 0.7346)

investment B:

y= 0.6399x + 0.0178 (the beta is 0.06399)

c. For investment A:
We have β= 0.7346 <1

Therefore, Investment A have less fluctuations than the market.

For investment B:

We have β= 0.6399 <1

Therefore, Investment B have less fluctuations than the market.

Q3)

We have:

Risk free rate (Rf) = 4%

Return on market (Rm) = 12%

a)

The most risky investment is “Investment 6” with highest beta value of 2, as we

know that the beta measures systematic risk and higher the beta higher is that risk.

While the least risky is “Investment 2” with the lowest beta value of 0.

b)

The CAPM (capital asset pricing model) is given by:

Re = Rf + Beta x (Rm - Rf)

Using the above equation, we get required returns as:

For Investment 1:

Required returns (Re) of Investment 1 = 4% + 1.5 x (12% - 4%)

Required returns (Re) of Investment 1 = 4% + 1.5 x (8%)

Required returns (Re) of Investment 1 = 4% + 12%

Required returns (Re) of Investment 1 = 16%

For Investment 2:

Required returns (Re) of Investment 2 = 4% + 0 x (12% - 4%)

Required returns (Re) of Investment 2 = 4% + 0

Required returns (Re) of Investment 2 = 4%

For Investment 3:

Required returns (Re) of Investment 3 = 4% + 1 x (12% - 4%)

Required returns (Re) of Investment 3 = 4% + 1 x (8%)

Required returns (Re) of Investment 3 = 4% + 8%

Required returns (Re) of Investment 3 = 12%

For Investment 4:

Required returns (Re) of Investment 4 = 4% + 0.5 x (12% - 4%)

Required returns (Re) of Investment 4 = 4% + 0.5 x (8%)

Required returns (Re) of Investment 4 = 4% + 4%

Required returns (Re) of Investment 4 = 8%

For Investment 5:

Required returns (Re) of Investment 5 = 4% + 0.75 x (12% - 4%)

Required returns (Re) of Investment 5 = 4% + 0.75 x (8%)

Required returns (Re) of Investment 5 = 4% + 6%

Required returns (Re) of Investment 5 = 10%

For Investment 6:

Required returns (Re) of Investment 6 = 4% + 2 x (12% - 4%)

Required returns (Re) of Investment 6 = 4% + 2 x (8%)

Required returns (Re) of Investment 6 = 4% + 16%

Required returns (Re) of Investment 6 = 20%

c)

Summary:

Investment Bet CAPM (Return)

 a

1 1.5 16.0%

2 0 4.0%

3 1 12.0%

4 0.5 8.0%

5 0.75 10.0%

6 2 20.0%
d)

On the basis of the chart we can notice as the risk (measured by beta) increase then
the required return also increases which show the relationship between risk and
return is positively correlated (greater the risk, higher the required return) and
shows a direct relationship.

What relationship exists between risk and return?

The graph above, the Security Market Line (SML), shows a positive linear
relationship between risk (measured by beta) and the required return.

According to the Capital Asset Pricing Model (CAPM), this relationship can be
described as follows:

• Higher risk leads to higher returns:

Investments with higher betas (i.e., more volatile compared to the market) require a
higher return to compensate investors for the increased risk.

• Lower risk leads to lower returns:

Investments with lower betas are less sensitive to market fluctuations, and thus,
offer lower expected returns.

In summary, the SML confirms the basic principle of risk and return: the greater
the risk, the higher the required return an investor expects.