Unit 6 Risk and Return.pdf (CFM22A2)

FINANCIAL MANAGEMENT 3B
ADDITIONAL STUDY MATERIAL 2014




Unit 6 Risk and Return

 T6.1 (LAO 2012)
PART A

Part a

Expected return: Arithmetic mean

Investment A = (12%+14%+16%)/3= 42%/3=14%



Geometric mean

[(1+0.12)(1+0.14)(1+0.16)]⅓ -1 =

Part b

Investment A = square root of (12%-14%)²+(14%-14%)²+(16%-14%)²/ (3-1) =
2%


PART B

a) Weighting
Investment A 4 million
Investment B 6 million
10 million

b) Expected return
(0.60)(25)+(0.40)(10)=19



c) Standard deviation:
[(0.4²*8²) + (0.6²*25²) +(2 * 0.4 * 0.6 * 80)]½=
244.456
15.64%


PART C

a)

CAPM = rf + b(rm-rf)=7 + 1.5(10-7)=11.5


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, FINANCIAL MANAGEMENT 3B
ADDITIONAL STUDY MATERIAL 2014



risk free rate 7%
beta 1.5
market return 10%

Required return 11.50%



b)
The required return (11.5%) is higher than the expected return (11%).
Therefore the project would be rejected.

c)
CAPM = rf + b(rm-rf)=7 + 1.5(9-7)=10

risk free rate 7%
beta 1.5
market return 9%

Required return 10.00%



The investment would be recommended as the required return of 10% is lower than the
expected return of 11%.


T6.2



Historic returns, variances and standard
a)
deviations




Market Aldworth Badenhorst
(rM – (rA – (rB –
Year rM rM x Pri rA rA x Pri rB rB x Pri
)2 )2 )2
1 22 7,6 57,76 10 –5,4 29,16 37 17 289,00
2 18 3,6 12,96 16 0,6 0,36 24 4 16,00
3 8 –6,4 40,96 16 0,6 0,36 –5 –25 625,00
4 14 –0,4 0,16 17 1,6 2,56 24 4 16,00


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