27 Jun Theo Has $600,000 To Invest And Is Considering The Merits
Theo has $600,000 to invest and is considering the merits of two securities. She is interested in the common shares of Corporation X and Corporation Y. The possible annual rate of return of security is shown as below:
Possible Annual Rate of Return of Security in 2018:
| State of Affair | Probability | Stock X | Stock Y |
| Boom | 0.2 | 25% | -5% |
| Normal | 0.6 | 15% | 10% |
| Recession | 0.2 | -10% | 20% |
Each part is independent
(a) Calculate the expected rate of return and variance of rate of return of Stock X and Stock Y. (8 marks)
(b) Assuming the weight of Stock X is 30% and the weight of Stock Y is 70%, calculate the expected rate of return and variance of the portfolio. Compare the portfolio risk with the risk of the stocks and explain the difference, if any. (10 marks)
(c) If the risk-free rate is 2%, the market risk premium is 10%, the beta of Stock X is 1.8 and the beta of Stock Y is 1.2, calculate the beta and the required rate of return of the portfolio as stated in part (b). And determine whether the portfolio is overpriced or underpriced. (5 marks)
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