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Question 5

The following are the annual returns for Large Co. and Small Co. as well as for the market, for the last 10 years.

Annual returns (%)

Year Large Small Market 1 13.00 15.00 6.00 2 8.00 16.00 5.00 3 1.00 4.00 4.00 4 8.00 2.00 5.00 5 9.00 12.00 8.00 6 6.00 10.00 7.00 7 12.00 8.00 9.00 8 8.00 -2.00 8.00 9 12.00 12.00 10.00 10 5.00 16.00 8.00

Calculate the following:

a. Average annual rate of return for Large, Small and the market

b. Standard deviation of the rate of return for Large, Small and the market

c. Plot Large Co, Small Co and the market on a risk / return graph. Which asset or combination of asset would you invest in? Why?

Question 6

Assume the long term Government bond rate is 4.1%.

a. If the BetaLARGE CO = 1, and the BetaSMALL CO = 0.44, construct the Security Market Line (SML) plotting Large Co, Small Co and the market

b. The expected returns for Large and Small are 5.4% and 9.3%, respectively; plot these returns on the same graph as in (a)

c. Consider each company, would you recommend an investor to: - buy shares in either company; - sell shares in either company; or - be indifferent between the shares of both companies?

Justify your recommendations

d. How does the measure of risk used in Question 6 differ from the measure of risk used in Question 5?

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