Question 2: Risk and Return (20 marks)

You wish to create a portfolio by investing in both Share A and Share B. The expected annual returns and expected return standard deviations of Share A and Share B are given below. The correlation coefficient between the two shares returns is 0.3.

Share	Expected Annual Return (%)	Expected Return Standard Deviation (%)
A	12	20
B	15	18

1. If you create a portfolio that is 40% invested in Share A and 60% invested in Share B, what is the expected standard deviation of the returns of this portfolio (Give your answer as a percentage rounded to two decimal places)? (7 marks)

(Please ensure that you show all working, you can insert a scan or photograph of handwritten workings if you wish).

2. Share A has a beta of 1.6 and Share B has a beta of 0.9. The risk-free rate is 3% per annum and the expected return of the market portfolio is 7% per annum. According to the capital asset pricing model (CAPM), what is the expected return of a portfolio that consists of 40% invested in Share A and 60% invested in Share B? (5 marks)

(Please ensure that you show all working, you can insert a scan or photograph of handwritten workings if you wish).

3. The market portfolios return decreases by 3% and there are no changes in the risk-free rate, by how much do you expect your portfolios return to change? (2 marks)

4. On December 31 2018, Cooklights share price was $8. A year later, Cooklights share price was $9. Cooklights shares do not pay dividends. An analyst estimated on December 31, 2018 that Cooklights shares expected CAPM one-year return was 10%. What was Cooklights 2019 share return? Give two possible explanations why Cooklights 2019 share return was not 10%. (3 marks)

5. Why are investors in both shares and bonds concerned when the correlation between share and bond returns increases? (3 marks)