Assume you are a recently appointed Senior Financial Advisor at a reputable JSE-listed financial services company, Stan and Brothers International Holding Ltd (hereafter called ‘SBIH’). The company’s services include investment advisory, insurance services and the granting of loans to individual clients and small businesses. At the beginning of May 2018, you were given data of two individual clients, Muofhe Matibe and Mulalo Mmbi, who are considering investing in selected JSE-listed companies. The two clients have provided SBIH with the list of companies that they would like to invest in. Mr Matibe is aged 48 and has just inherited a large sum of money from his uncle. After paying off his home loan and vehicle finance accounts, he would like to invest 60% of the remaining amount in Sanlib Ltd and 40% will be invested in Mutual and Co Ltd. Both companies operate in the financial services sector and are listed on the JSE. The expected returns on the two companies’ shares depend on the economic state of the country. The state of the economy can be a boom, high growth, steady growth or in recession. The equity research
3
department of SBIH has compiled the following information about the performance the expected rates of returns of the two companies’ shares:
Economic state
Probability of state
Return of Sanlib Ltd
Return of Mutual and Co Ltd
Average return
0.25
30%
22%
Variance
0.35
18%
20%
Standard deviation
0.30
12 %
14%
Recession
0.10
-14%
0%
The second client, Mr Mmbi, already holds a well-diversified portfolio of shares and would like to add the shares of two JSE-listed construction companies, Willard (W) Ltd and Vhembe (V) Ltd. Again, the SBIH equity research department provided the following historic information about the average return, variance of returns and the standard deviation of returns of the market and the two companies’ shares over the last five years, from 2013 to 2017:
The Market
Willard Ltd
Vhembe Ltd
Average retrun
14.8%
10.4%
22%
Variance
22.96%
15.04%
33.2%
Standard deviation
5%
3.88%
5.76%
The covariance of the two companies in the portfolio is as follows: COVWM = 19.08, COVVM = 28.2 and COVWV 2.4. In 2018, Mr Mmbi expects the return on the market to be 18%. The risk-free rate is expected to be 8.15. The expected returns on the shares of Willard Ltd and Vhembe Ltd in 2018 are 10.4% and 22%, respectively.
3.1. Determine the expected return and standard deviation of returns for Sanlib Ltd and Mutual and Co Ltd. Advise as to the better investment option between these two. (15)
3.2. Calculate the covariance and correlation coefficient between the returns of Sanlib Ltd and Mutual and Co Ltd and giving interpretation of the same in respect of these two companies. (8)
3.3. Determine the expected return and standard deviation of Mr. Matibe’s entire portfolio. (4)
3.4. Calculate the beta coefficient of the shares of Willard Ltd and Vhembe Ltd, the companies Mr. Mmbi would like to extend his investment stake in, and comment on these betas. (3)
4

Answer rating: 100% (QA)

31 The expected return and standard deviation of returns for Sanlib Ltd and Mutual and Co Ltd can be calculated by using the following formula Expected Return ER PBoomRb PHigh GrowthRh PSteady GrowthR... View the full answer