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Page 1 of 4 Chua, Francis Czeasar M.Homework in BA 14205 December 2013

P5-16. Total, Nondiversifiable, and Diversifiable Risk

a. & b.

c. The nondiversifiable risk is the relevant component of the total risk that DavidTalbots portfolio bears. This is because, the diversifiable aspect of such risk could simply

be minimised by adding more number of shares to his portfolio. As shown in the graph,the diversifiable component of the portfolios risk is practically eliminated by adding 20shares on the said portfolio. Given the data, it could be safely assumed that at most

6.47% is nondiversifiable risk.

P5-17. Graphical Derivation of Beta

a.

b. m ASSET A = 0.790672 *computed using excel function m ASSET B = 1.378679 *computed using excel function

c. As observed through the slopes of the characteristic lines of the two assets vis--vis themarket rate of return, which in turn reflects the betas of the two assets, asset B is riskieras it responds more quickly to movements of the market rate of return than asset A.

Diversifiable

Nondiversifiable


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P5-18. Interpreting Beta

a. 1.20 x (15%) = 18.0%*One would expect an 18% increase on the assets return.

b. 1.20 x (-8%) = -9.6%

*One would expect a decrease of 9.6% on the assets return.

c. 1.20 x (0%) = 0 ( no change on the asset s return )

d. It could be said that the asset (with a beta of 1.2) is more risky than the market portfolio, which has a beta of 1. The higher beta makes the return on the asset respond 1.2 times as fast as that of the marketrate of return.

P5-21. Portfolio Betasa.

PORTFOLIO A PORTFOLIO B Asset Beta Weight Weight x Beta Weight Weight x Beta

1 1.3 .1 .130 .3 .392 0.70 .3 .210 .1 .073 1..25 .1 .125 .2 .254 1.10 .1 .110 .2 .225 .90 .4 .360 .2 .28

Beta A 0.935 Beta B 1.11

b. When compared to the market return, Portfolio A is less risky while Portfolio B is slightly riskier as ithas a higher beta. Needless to say that Portfolio B is riskier that Portfolio A for the former wouldrespond more quickly to changes in the market return than the latter.

P5-22. Capital Asset Pricing Model

Case (j) R F r m b j r j= R F+[ b j(r m - R F)] A 5% 8% 1.3 8.9%B 8% 13% .9 12.5%

C 9% 12% -.2 8.4%D 10% 15% 1 15%E 6% 10% .6 8.4%

P5-24. Manipulating CAPM

a. r j= 8% + [0.90 (12%-8%)]= 11.6%

b. 15%= R F + [1.25 (14%-R F)]

R F = 10%

c. 16% = 9% + [1.1 (r m-9%)]rm = 15.36%

d. 15% = 10% + [b j (12.5% - 10%)] b j = 2


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RA1 = 12.4% (b)

P5-26. Security Market Line

a & b.

c. Asset A:

r A = 9% + [0.8 ( 13% - 9%) ]

= 12.2 %

Asset B:rB = 9% + [1.3 ( 13% - 9%) ]

= 14.2 %

d. Risk premiums are labelled in presented graph. As observed in the plotted points, it could be saidthat the risk premium of Asset A is lower than that of Asset B. This could be attributed to the fact that,using the beta as a measure of nondiversifiable risk, Asset A is less risky.

P5-27. Shifts in Security Market Line

a,b,c &d.

R A1= 8% + [1.1 (12% - 8%)]= 12.4%

R A2= 6% + [1.1 (10% - 6%)]= 10.4%

R A3= 8% + [1.1 (13% - 8%)]= 13.5%

e. It could be observed that a decrease in inflationary expectations decreases the required return whileincreased risk aversion results to a steeper SML increasing the increase in required return for anincrease in the nondiversifiable risk.

RF

RP(4%)

RP(3.2%)

RP(5.2%)

RA 2 = 10.4% (c)

RA 3 = 13.5% (d)


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