Page 1 of 4 Chua, Francis Czeasar M. Homework in BA 142 05 December 2013 P5-16. Total, Nondiversifiable, and Diversifiable Risk a. & b.

Diversifiable Nondiversifiable

c. The nondiversifiable risk is the relevant component of the total risk that David Talbots portfolio bears. This is because, the diversifiable aspect of such risk could simply be minimised by adding more number of shares to his portfolio. As shown in the graph, the diversifiable component of the portfolios risk is practically eliminated by adding 20 shares on the said portfolio. Given the data, it could be safely assumed that at most 6.47% is nondiversifiable risk.

P5-17. Graphical Derivation of Beta a.

b. c.

mASSET A= 0.790672 *computed using excel function mASSET B= 1.378679 *computed using excel function
As observed through the slopes of the characteristic lines of the two assets vis--vis the market rate of return, which in turn reflects the betas of the two assets, asset B is riskier as it responds more quickly to movements of the market rate of return than asset A.

Page 2 of 4 Chua, Francis Czeasar M. Homework in BA 142 05 December 2013

P5-18. Interpreting Beta a. 1.20 x (15%) = 18.0% *One would expect an 18% increase on the assets return. b. 1.20 x (-8%) = -9.6% *One would expect a decrease of 9.6% on the assets return. c. 1.20 x (0%) = 0 (no change on the assets return) d. It could be said that the asset (with a beta of 1.2) is more risky than the market portfolio, which has a beta of 1. The higher beta makes the return on the asset respond 1.2 times as fast as that of the market rate of return. P5-21. Portfolio Betas a. PORTFOLIO A
Asset Beta Weight Weight x Beta

PORTFOLIO B
Weight Weight x Beta

1 2 3 4 5

1.3 0.70 1..25 1.10 .90

.1 .3 .1 .1 .4 BetaA

.130 .210 .125 .110 .360 0.935

.3 .1 .2 .2 .2 BetaB

.39 .07 .25 .22 .28 1.11

b. When compared to the market return, Portfolio A is less risky while Portfolio B is slightly riskier as it has a higher beta. Needless to say that Portfolio B is riskier that Portfolio A for the former would respond more quickly to changes in the market return than the latter.

P5-22. Capital Asset Pricing Model Case (j) A B C D E RF 5% 8% 9% 10% 6% rm 8% 13% 12% 15% 10% bj 1.3 .9 -.2 1 .6 rj= RF+[ bj(rm- RF)] 8.9% 12.5% 8.4% 15% 8.4%

P5-24. Manipulating CAPM a. rj= 8% + [0.90 (12%-8%)] = 11.6% b. 15%= RF + [1.25 (14%-RF)] RF = 10% c. 16% = 9% + [1.1 (rm-9%)] rm = 15.36% d. 15% = 10% + [bj (12.5% - 10%)] bj = 2

Page 3 of 4 Chua, Francis Czeasar M. Homework in BA 142 05 December 2013 P5-26. Security Market Line a & b.

RP (3.2%)

RP (4%)

RP (5.2%)

RF

c. Asset A: rA = 9% + [0.8 ( 13% - 9%) ] = 12.2 % Asset B: rB = 9% + [1.3 ( 13% - 9%) ] = 14.2 % d. Risk premiums are labelled in presented graph. As observed in the plotted points, it could be said that the risk premium of Asset A is lower than that of Asset B. This could be attributed to the fact that, using the beta as a measure of nondiversifiable risk, Asset A is less risky. P5-27. Shifts in Security Market Line a,b,c &d. RA1= 8% + [1.1 (12% - 8%)] = 12.4% RA2= 6% + [1.1 (10% - 6%)] = 10.4% RA3= 8% + [1.1 (13% - 8%)] = 13.5%

RA 3 = 13.5% (d) RA1 = 12.4% (b) RA 2 = 10.4% (c)

e. It could be observed that a decrease in inflationary expectations decreases the required return while increased risk aversion results to a steeper SMLincreasing the increase in required return for an increase in the nondiversifiable risk.

Page 4 of 4 Chua, Francis Czeasar M. Homework in BA 142 05 December 2013 P5-28. IntegrativeRisk, Return and CAPM a. SML 1 Project (j) A B C D E b.
SML 1 SML 2

Beta (bj) 1.5 .75 2 0 -0.5

Required Return, % (rj) = 9% + [ bj (5%)] 16.5 12.75 19 9 6.5

c. With the roster of Projects given, the following interpretations could be made: Project A responds 150% to changes in market return, moving in the same direction. Project B responds 75 % to changes in market return, moving in the same direction. Project C responds 200 % to changes in market return, moving in the same direction. Project D is unaffected by changes in market return. Project E responds 50 % to changes in market return, moving in the opposite direction.

d. SML 2 (Plotted on previously presented graph) Project (j) A B C D E Beta (bj) 1.5 .75 2 0 -0.5 Required Return, % (rj) = 9% + [ bj (3%)] 13.5 11.25 15 9 7.5

e. When a decrease in risk aversion happens in the market, the SML becomes less steepthus, a decrease in the required increase in the market return for every change in nondiversifiable risk could be observed.