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Question
(a) Firm A has a standard deviation of 42 percent per year and a beta of +0.10. Firm B has a standard deviation of 31 percent a year and a beta of +0.66. Explain why Firm A is the safer investment for a diversified investor.
(b) If an investment with a beta of 1.5 offers an expected return of 20%, should you proceed with the investment? Where will this investment plot in relation to the security market line? Assume that the government bond rate is 6, and the expected return on the market portfolio is 14%.
(c) The standard deviations of returns on assets A and B are 8 percent and 12 percent respectively. A portfolio is constructed consisting of 30 percent in asset A and 70 percent in asset B. Calculate the portfolio standard deviation if the correlation of returns between the two assets is: (a) +1.0 (b) 0 (c) -1.0 Comment on your answers.
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