Question 4 [25 marks]

4.1 You are given the following data regarding the returns on stocks A and B.

What is the expected return and standard deviation of a portfolio that is formed by a 64% holding of stock A and with the remainder in stock B? (13 marks)

4.2 (i) Having made stock investments in the Royal Bank of Scotland, Barclays Bank, Standard Chartered Bank and HSBC Bank, Ed believes he holds a welldiversified portfolio. Do you agree? Explain why / why not.

(ii) Is it possible for a risky security to have a negative beta and if so, what would that imply about the securitys expected return? Explain. (iii)Consider the following securities: Security A, which has an expected return of 19% and Security B which has an expected return of 16%. The beta of Security A is 1.5, while that of security B is 1.0. How can we determine if either of these securities are over / under valued?

(12 marks)

Scenario Probability Return on Stock A (%) 0.08 -40 Returns on Stock B (%) 12 0.19 -15 10 Severe Recession Mild Recession Normal Growth 0.4 19 8 8 Boom 0.33 30 -5