There are only shares of A and B companies in the market. Currently, the market value of A and B shares is $200 million and $300 million, respectively. In addition, the risk-free interest rate (Rf) is 5 per cent. The probability and rate of return for the future state of the two entities are given as follows: (Value values with a decimal place or higher to the fifth decimal place.) 1) Obtain the expected return and variance of Entity A and B, respectively. 2) When forming a market portfolio with two shares, obtain the expected return rate and variance and standard deviation of the market portfolio. 3) Calculate the beta of share A, and calculate the required yield of share A. state probability Ra Rb 1 0.3 0.30 0.20 2 0.4 0.15 -0.10 3 0.3 0.05 0.10
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
There are only shares of A and B companies in the market. Currently, the market value of A and B shares is $200 million and $300 million, respectively. In addition, the risk-free interest rate (Rf) is 5 per cent. The probability and
1) Obtain the expected return and variance of Entity A and B, respectively.
2) When forming a market portfolio with two shares, obtain the expected return rate and variance and standard deviation of the market portfolio.
3) Calculate the beta of share A, and calculate the required yield of share A.
| state | probability | Ra | Rb |
| 1 | 0.3 | 0.30 | 0.20 |
| 2 | 0.4 | 0.15 | -0.10 |
| 3 | 0.3 | 0.05 | 0.10 |
1.
| State | Probability | Ra | Ra2 | Ra2p | Rb | Rb2 | Rb2p |
| 1 | 0.3 | 0.30 | 0.09 | 0.027 | 0.20 | 0.04 | 0.012 |
| 2 | 0.4 | 0.15 | 0.0225 | 0.009 | -0.10 | 0.01 | 0.004 |
| 3 | 0.3 | 0.05 | 0.0025 | 0.00075 | 0.10 | 0.01 | 0.003 |
| 0.03675 | 0.019 |
Variance(X) = Σx2p − μ2
Mean(μ) Ra=0.165; μ2=0.027225
S.D.=
Mean(μ) Rb=0.05; μ2=0.0025
S.D.=
Expected return of Entity A
Expected return of Entity B
Mean(μ) Ra=0.165; μ2=0.027225
S.D.=
Mean(μ) Rb=0.05; μ2=0.0025
S.D.=
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