Q2. E Berhad has been specially formed to undertake two investment opportunities. The risk and return characteristics of the two projects are shown below:

A B Expected return 12% 20% Risk 3% 7%

E Berhad plans to invest 80% of its available funds in Project A and 20% in Project B. The directors believe that the correlation coefficient between the returns of the projects is +0.1.

Required:

(a) Calculate the returns from the proposed portfolio of Project A and Project B. (5 marks)

(b) Calculate the risk of the portfolio. (5 marks)

(c) Comment on your calculations in part (b) in the context of the risk reducing effects of diversification. (Hint: You need to calculate the weighted average risk of the portfolio first.) (8 marks)

(d) Suppose the correlation coefficient between Project A and Project B was 1.0. Determine how E Berhad would invest its funds in order to obtain a zero-risk portfolio? (12 marks)