Reference no: EM132613367

a) Consider two risky assets (X and Y) that have a standard deviation of 25% and 18% respectively. Compute the variances and standard deviations of portfolio returns for an equal weighted portfolio of the two assets when their correlation of return is: i) Ρxy = 1.00, ii) Ρxy = 0.50, iii) Ρxy = 0, iv) Ρxy= -0.50

b) The table below contains information based on an analyst's forecasts for three stocks. The risk free rate is 8% and the market return is 16%.

Stock Current stock price(ksh) Exptd stock price(ksh) Expectd dividend(ksh) Beta

p 25 27 1 1

Q 40 45 2 0.8

R 15 17 0.5 1.2

Required

i) Compute the expected return on each stock

ii) Compute the required return on each stock

iii) Determine whether each stock is undervalued, overvalued or correctly valued

iv) Outline an appropriate trading strategy

v) What are the limitations of the capital asset pricing model when used to make investment decisions