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You have just been hired by Jackson Investment Services. Your first task is to invest \( \$ 125,000 \). The following investment alternatives and other relevant data are as follows: In addition, the market is expected to earn a return of \11 and the Treasury Bills are expected to earn \6. Required: (a) Calculate the expected return on each stock. (6 marks) \[ \begin{array}{ll} \beta_{J}=\left(\ ho_{J M}\ ight)\left(\frac{\sigma_{J}}{\sigma_{M}}\ ight) & E\left(r_{J}\ ight)=r_{f}+\beta_{J}\left[E\left(r_{M}\ ight)-r_{f}\ ight]=r_{f}+\beta_{J}[M R P] \\ \beta_{A}=(0.85) \frac{(0.30)}{(0.15)}=1.70 & E\left(r_{A}\ ight)=0.06+1.70(0.05)=14.5 \% \\ \beta_{B}=(0.70) \frac{(0.18)}{(0.15)}=0.84 & E\left(r_{B}\ ight)=0.06+0.84(0.05)=10.2 \% \\ \beta_{C}=(0.90) \frac{(0.27)}{(0.15)}=1.62 & E\left(r_{C}\ ight)=0.06+1.62(0.05)=14.1 \% \end{array} \] (b) Compute the expected return and standard deviation of a portfolio made up of \( \$ 50,000 \) of Stock ADK and the remainder in Stock BBL. (4 marks) \[ \begin{aligned} \mathrm{x}_{\mathrm{A}} & =0.4 \quad \mathrm{x}_{\mathrm{B}}=0.6 \\ \mathrm{r}_{\mathrm{P}} & =(0.4)(0.145)+(0.6)(0.102)=11.92 \% \\ \sigma_{\mathrm{P}}^{2} & =(0.4)^{2}(0.30)^{2}+(0.6)^{2}(0.18)^{2}+2(0.40)(0.6)(0.30)(0.30)(0.18) \\ & =0.0144+0.011664+0.07776 \\ & =0.03384 \\ \sigma_{P} & =0.18396 \approx 18.4 \% \end{aligned} \] Suppose instead that risk aversion increased sufficiently to cause the market risk premium \( \left[E\left(r_{M}\ ight)-r_{f}\ ight] \) to increase by \2. What effect would this have on the Security Market Line and on the returns of BBL and CRL stocks? (3 marks) The SML would become steeper, resulting in the expected or required returns becoming greater. \beginarraylEleft(rJright)=0.06+betaJ(0.07)Eleft(rBright)=0.06+0.84(0.07)=11.88

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