Portfolio theory
Given the following information about firm A and the market:δ
E (Rm)= 12 per cent δm= 10 per cent ρA,M =0.95 Rf = 4 per cent δA = 12 per cent
(i) Calculate the beta and the required rate of return for firm A.
(ii) Assume that an analyst, using fundamental analysis, estimates the expected return for firm A to be 15%. Is stock A overvalued or undervalued? Why?
(iii) Assume that an investor puts 70 per cent in the market portfolio and 40 per cent in the risk-free asset. What would the expected return and standard deviation of the portfolio be?
1.
Beta=0.95*12%/10%=1.14
Required return=4%+1.14*(12%-4%)=13.12%
2.
Undervalued as it is offering more return than is required
3.
Expected return=70%*12%+30%*12%=12.00%
Standard deviation=70%*10%=7%
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