Answer Happy

Question 3 a) You currently have all of your £1,000,000 wealth invested in an aggressive portfolio of UK stocks which has a beta of 1.3. You are concerned that this is too risky a position. You can also invest (both long and short) in a defensive UK stock portfolio which has a beta of exactly 0.3. You wish to re-allocate your wealth so that some is invested in the aggressive portfolio and the rest in the defensive portfolio and so that your overall beta is 0.5. What are your portfolio weights on the aggressive asset and the defensive asset? (10 marks) b) A market consists of only two stocks, X and Y. The market cap of X is $3bn and that of Y is $7bn. X has an expected return of 10% and a return standard deviation of 32%. Y has an expected return of 8% and a standard deviation of 20%. Their return correlation is 0.25. i) What is the expected return on the market and the return standard deviation of the market? (10 marks) ii) What are the CAPM betas of X and Y? (10 marks) Assume that you believe in the Capital Asset Pricing Model. You believe that you have, through extensive research, identified a stock that plots below the Security Market Line. What does this imply for whether or not it is fairly priced? How would you exploit this situation? [Write no more than 5 sentences in your answer.] (10 marks)