Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

Mr. Mlachake is currently holding a portfolio consisting of shares of four companies quoted on the Bahati Stock Exchange as follows:
The current market return is 14% per annum and the treasury bills yield is 9% per annum.

Required:
(i) Calculate the risk of Mlachake‟s portfolio relative to that of the market.
(ii) Explain whether or not Mlachake should change the composition of his portfolio.

ANSWER

(i)The risk of the portfolio in this case will be measured portfolio Beta (Bp) relative to market portfolio beta.


Where wn = weight based on market values of shares.

(ii)Compute the required return using CAPM and compare with expected returns to determine whether the securities are over or undervalued.


Change the composition of the portfolio since:

Some securities (A&B) are undervalued Security C is overvalued
4 securities are too few to constitute a portfolio and fall eliminate unsystematic risk

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