Question No. 2 Portfolio & CAPM [TOTAL MARKS:50] A client, JP McMillan has asked you for investment advice. He is planning to invest in a portfolio of shares. Details are as follows: Share 1 -RCH PLC a company in the construction industry. Expected annual returns are as follows: Investment Return 8% 10% 12% Probability 0.3 0.2 0.5 Share 2 - Perry Foods PLC a company in the food sector. Expected annual returns are as follows: Investment Return 10% 15% 20% Probability 0.3 0.2 0.5 JP plans to invest 500,000 - investing 60% of his funds in RCH PLC shares and the remaining 40% in Perry Foods PLC shares. Required: (a) Calculate the expected return, the variance and the standard deviation for each share. [10 Marks] (b) Calculate the standard deviation for this combined portfolio if (0) There is perfect positive correlation (ii) There is perfect negative correlation [8 Marks] (c) Comment on the significance of the figures calculated in part (b). [4 Marks] (d) Explain the terms portfolio theory, systematic risk and unsystematic risk. [10 Marks] (e) "The CAPM (Capital Asset Pricing Model) is based on a development of Markowitz's portfolio theory". Describe this model and how it can be used to help a finance manager make investment decisions. [18 Marks] [End of Question 2]