a) The data presented below represents the expected returns on a financial asset in different

seasons of the year.

Season of year Probability Returns

Spring 40% 2%

Summer 35% 6%

Winter 25% 10%

i) What is the expected return on the asset? (4 marks)

ii) What is the standard deviation on the asset? (6 marks)

iii) What is the covariance of the asset? (2 marks)

iv) What is meant by Diversification and it effect on risk and return on a portfolio?

(3marks)

b) You are given the following data about Asset A and Asset B.

Asset A Asset B

Expected returns 8.6% 7.9%

Standard Deviation 3.8% 4.6%

Assuming that an investor is to choose between Asset A or Asset B, explain which asset

a rational investor will choose. (3 marks)

c) With the use of a diagram, explain why an investor will always choose a point on the

SML line. (