TOPIC 4 : RISK AND RETURN

Specific issues
Describe risk and return concepts
Measuring risk and return for a single
security
Portfolio risk and return
Diversification
Capital Asset Pricing Model (CAPM) and
APT

1
 RETURN
Defn: Is a any gain (or loss) from an investment of any sort.

Components
Income component: Is the cash received directly while you own your
investment.
Capital gain or Capital loss on your investment: Refers to the asset
due to change in price or the part arises from changes in the value of your
investment.

Expression of Return:
Can be expressed in amount form or in percentage form.

2
 General Formula for Return
Return = Dividend received + Capital gain (loss)
Or

R = [D + (P1 – Po) ] x100

Po
Where :
R = return, D = Dividend received, Po = Beginning price, P1 = Ending
price

Therefore, Total amount return = Dividend income (D) + Capital

gain (loss) (P1 – Po)
3
Example 1:
At the beginning of the year, the stock was selling for $ 37 per share. If you
bought 100 shares, you would have had a total outlay of $ 3,700. Suppose, over
the year the stock paid a dividend of $ 1.85 per share, and the value of stock
risen to $ 40.33 per share at the end of the year. Determine the total return in
amount and in percentage at the end of the year.
Solution: In amount
Dividend = $1.85 x 100 = $185
Capital gain = ($40.33-37) x 100 =$333
Total return = Dividend income + Capital gain (or loss)
Thus, Total amount return = $185 + 333 = $518

You can make it when if the price had dropped to say, $34.78, you would
have a capital loss of:
Capital loss = ($34.78-37) x 100 = -$222

Qn: What is a total cash if stock is sold? Cross check vs stock sale+dividends.

4
 Solution: In percentage
Note that the expression in % is more convenient as it summarizes
information rather than in amount terms. This is because we are much
interested on how much do we get for each Tsh/$ we invest rather how
much we actually invest.
Thus: two parts are involved- Dividend Yield and Capital gain(loss) Yield.
Dividend Yield- expressing the dividend as a percentage of the beginning
stock price. D/Po x100 = $1.85/37 *100 = 5%
This implies that, for each dollar we invest we get five cents in dividends.

Capital gains Yield- Change in the price during the year divided by the
beginning price. Ie. (P1-P0)/P0 x100 = ($40.33-37)/37*100 = 9%.
So, per dollar invested , we get nine cents in capital gain. In totality we get
14 cents
5
 Unrealized Capital gain/loss
Suppose you hold your stock and don’t sell it at the end of the year.
Should you consider the capital gain as part of your return?
The answer is Yes, this is because the capital gain is every bit as
much a part of your return as the dividend, you should certainly count
it as part of your return. Decision to keep the stock and not to sell
(you don’t realize the gain) is irrelevant because you could have
converted it to cash if you had wanted to, Whether you choose to so
or not is up to you.

6
 Variability of Return
Return of an asset can be viewed into two aspects: Historical returns and
Projected returns.
Variability means the dispersion of returns from its mean or average score.
Or is the deviation of actual returns from average return in a particular time.
Actually, this measures how volatile/unpredictability the return is.

The measures in historical returns are Variance and Standard deviation.

Variance : The average squared difference between the actual return and
the average return.
Standard deviation: The positive square root of the variance.
Var (δ2) = 1/T-1[(R1-µ)2 + ………+(RT -µ)2]
Where: T = Total no of returns, µ = Mean score of returns, R = Return

Standard deviation(δ) = var 7

 Variability of Return Cont.
Note that, the larger the variance or standard deviation is the more
spread out the returns will be.
Example 2 Table 1
Year Honda Returns (%) Toyo Returns (%)
1993 -0.20 0.05
1994 0.50 0.09
1995 0.30 -0.12
1996 0.10 0.20
Variance 0.2675/3 = 0.0892 0.529/3 = 0.0176
Standard dev 0.2987 = 30% 0.1327 = 13%
Therefore, Honda is more volatile investment.

8
 Class Task : Table 2

For the given data of security X and Y, calculate

average return, variance and standard deviation.
Returns (%) Returns (%)
Year Security X Security Y
1 18 26
2 6 -7
3 -9 -20
4 13 31
5 7 16

9
 Risk
Risk is defined as the possibility that actual future returns deviate from
expected returns. It represents the variability of returns. Or is defined
as the possibility that the actual cash flows (returns) will be different
from forecasted cash flows (returns).
Measures of Risk
There are many ways, but common methods are
1. Standard deviation – Coefficient of Variability
2. Beta coefficient
3. Subjective estimates/Sensitivity analysis

10
 Concepts of Risk
• Risk is the variability of actual return from the
expected return associated with a given asset.
• Sensitivity analysis is behavioral approach to
assess risk using a number of possible return
estimates to obtain a sense of variability among
outcomes.
• Range is measure of risk which is found by
subtracting pessimistic (worst) outcome from
optimistic (best) outcome.

11
 Concepts of Risk
• Probability is the chance that a given outcome
will occur.
• Probability distribution is a model that relates
probabilities to the associated outcome.
• Expected value is the most likely return on a
given asset/security. Or, is an average return or
simply equal to the sum of possible returns
multiplied by their probabilities. Sum of Ri * Pi.
• Standard deviation of return/risk refers to the
dispersion of returns around an expected value.
12
 Concepts of Risk

• Coefficient of variability is a measure of

relative dispersion used in comparing the risk of
assets with differing expected returns.
• Risk premium: the difference between expected
return on risky investment and certain return on risk-
free investment.

13
 Computations of the Concepts of Risk
• Sensitivity analysis

• Based on range of annual returns asset Y is more

risky.
14
 Computations of the Concepts of Risk

Risk premium: the difference between expected return on risky

investment and certain return on risk-free investment.
Eg. In Table 3, suppose risk-free investment is offers a return of 8% and
the expected return on stock U is 20%. Then the risk premium is
calculated as: = Expected return – risk free rate.= 20%-8% = 12%
Expected return: is an average return or simply equal to the sum of
possible returns multiplied by their probabilities. Sum of Ri * Pi
State of Probability Stock L Stock U
economy16
Recession 0.50 -20% 30%
Boom 0.50 70 10
Exp. return = -0.2*0.5+0.7*0.5 = 0.3*0.5+0.1*0.5 =
= 25% 20%

15
 Dispersion of returns (SD)
This is done by computing Variance or
Standard deviation.
Example. For stock L
Var = (-0.2-0.25)2 *0.5 + (0.7-0.25)2 *0.5
= 0.2025
SD = Square root of Var = 0.45*100= 45%

Do the same for stock U

16
 Standard Deviation

It is defined as the square root of the weighted average squared

deviations of possible outcomes from expected value. It measures
the variability of returns that is risk involved in the asset. The larger of
it, the more are an investment returns and the riskier is the
investment. A std of zero implies no variability and thus no risk.
Note that, the information about the expected return and standard
deviation help to make decision about investment. However, this
depends on the investor’s preference of risk: Risk seeker, Risk-
neutral, and Risk- averse.
Risk seeking investor likes investment with high risk irrespective of
the rates of return. Risk-averse investor will prefer investments with
higher rates of return and lower standard deviations. However, in
reality (if not all) investors are risk-averse.
17
 Coefficient of Variability (CV)
CV is the relative measure of risk. Std is not stable for comparing investments
of equal expected returns, because it is an absolute measure of variability.
That case, CV provides a better measure of risk. It is defined as the ratio of std
to the expected return.

CV = Std/Exp It measures the risk per unit expected return. As CV increases,

the risk of an asset increases. This is an example of Table 4
Asset T S
Expected Return % 25 10
Standard Deviation % 20 18
CV = 20/25 = 0.8 = 18/10 = 1.8

Security T is less riskier.

Note: comparing two equal investments, Std is an appropriate measure of risk,
when returns are different, then CV is appropriate measure of risk. 18
 Portfolio Risk
• Three concepts are important here
• i) Portfolio
• Ii) Portfolio Theory
• ii) Expected return of portfolio
• iv) Risk of portfolio

19
 Portfolio Risk cont..
• A portfolio is a bundle or a combination of individual assets or
securities.
• Portfolio theory provides a normative approach to investors to
make decisions to invest their wealth in assets or securities
under risk. It is based on the assumption that investors are
risk-averse. This implies that investors hold well-diversified
portfolios instead of investing the entire wealth in a single
asset or security. Also, the theory works under the assumption
that returns of securities are normally distributed. This mean
that the mean (the expected value) and variance (or standard
deviation) analysis is the foundation of the portfolio decisions.
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 PORTFOLIO RETURN: TWO-ASSET CASE

• The return of a portfolio is equal to the weighted average of

the returns of individual assets (or securities) in the portfolio
with weights being equal to the proportion of investment
value in each asset.
• We can use the following equation to calculate the
expected rate of return of individual asset:

21
 Expected Rate of Return: Example
Suppose you have an opportunity of investing your wealth
either in asset X or asset Y. The possible outcomes of two
assets in different states of economy are as follows:

Possible Outcomes of two Assets, X and Y

Return (%)
State of Economy Probability X Y
A 0.10 –8 14
B 0.20 10 –4
C 0.40 8 6
D 0.20 5 15
E 0.10 –4 20
The expected rate of return of X is the sum of the product of outcomes and their respective
probability. That is:
E ( Rx ) = (- 8´ 0.1) + (10 ´ 0.2) + (8´ 0.4) + (5 ´ 0.2)
+(- 4 ´ 0.1) = 5%
Similarly, the expected rate of return of Y is:
E ( Ry ) = (14 ´ 0.1) + (- 4 ´ 0.2) + (6 ´ 0.4) + (15´ 0.2)
+ (20 ´ 0.1) = 8%
22
 PORTFOLIO RISK: TWO-ASSET CASE

• Risk of individual assets is measured by their

variance or standard deviation.

• We can use variance or standard deviation to

measure the risk of the portfolio of assets as well.

• The risk of portfolio would be less than the risk of

individual securities, and that the risk of a security
should be judged by its contribution to the portfolio
risk.
23
 Measuring Portfolio Risk for Two Assets

• The portfolio variance or standard deviation depends on the co-

movement of returns on two assets.
• Covariance of returns on two assets measures their co-movement.
• Three steps are involved in the calculation of covariance between two
assets:

• Determining the expected returns on assets.

• Determining the deviation of possible returns from the expected
return for each asset.
• Determining the sum of the product of each deviation of returns of
two assets and respective probability.

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 Example
Deviation from Product of
State of Expected Deviation &
Economy Probability Returns Returns Probability
X Y X Y
A 0.1 –8 14 – 13 6 – 7.8
B 0.2 10 –4 5 – 12 – 12.0
C 0.4 8 6 3 –2 – 2.4
D 0.2 5 15 0 7 0.0
E 0.1 –4 20 –9 12 – 10.8
E(RX) E(RY) Covar = –33.0
=5 =8

25
 Example
The standard deviation of securities X and Y are as follows:

s 2x = 0.1(- 8 - 5) 2 + 0.2(10 - 5) 2 + 0.4(8 - 5) 2

+0.2(5 - 5) 2 + 0.1(- 4 - 5) 2
= 16.9 + 3.6 + 0 + 8.1 = 33.6
sx = 33.6 = 5.80%
s 2y = 0.1(14 - 8) 2 + 0.2(- 4 - 8) 2 + 0.4(6 - 8) 2
+0.2(15 - 8) 2 + 0.1(20 - 8) 2
= 3.6 + 28.8 +1.6 + 9.8 +14.4 = 58.2
sy = 58.2 = 7.63%

The correlation of the two securities X and Y is as follows:

- 33.0 - 33.0
Corxy = = = - 0.746
5.80 ´ 7.63 44.25

Securities X and Y are negatively correlated. The

correlation coefficient of – 0.746 indicates a high negative
relationship.
26
Measuring Portfolio Risk for Two Assets

27
Correlation

28
 Correlation

• The value of correlation, called the correlation

coefficient, could be positive, negative or zero.
• It depends on the sign of covariance since standard
deviations are always positive numbers.
• The correlation coefficient always ranges between
–1.0 and +1.0.
• A correlation coefficient of +1.0 implies a perfectly
positive correlation while a correlation coefficient
of –1.0 indicates a perfectly negative correlation.

29
Variance and Standard Deviation of a
Two-Asset Portfolio

30
Minimum Variance Portfolio

31
 Portfolio Risk Depends on
Correlation between Assets
• Investing wealth in more than one security reduces portfolio risk.
• This is attributed to diversification effect.
• However, the extent of the benefits of portfolio diversification
depends on the correlation between returns on securities.
• When correlation coefficient of the returns on individual securities
is perfectly positive then there is no advantage of diversification.
The weighted standard deviation of returns on individual
securities is equal to the standard deviation of the portfolio.
• Diversification always reduces risk provided the correlation
coefficient is less than 1.

32
 Minimum variance portfolio
• When correlation is positive or negative, the
minimum variance portfolio is given by the
following formula:

33
 Investment Opportunity Set:
The n-Asset Case
• An efficient portfolio is one that has the
highest expected returns for a given level of
risk.
• The efficient frontier is the frontier formed by
the set of efficient portfolios.
• All other portfolios, which lie outside the
efficient frontier, are inefficient portfolios.

34
 Efficient Portfolios of risky securities

An efficient
portfolio is one
that has the highest
expected returns for
a given level of risk.
The efficient
frontier is the
frontier formed by
the set of efficient
portfolios. All other
portfolios, which lie
outside the efficient
frontier, are
inefficient 35
 Diversification
Categories of Risk
Business and Financial risk
Systematic and Unsystematic risk

Systematic risk is a risk that influence a large number of assets

or security market as a whole, also called market risk. Eg
inflation
Unsystematic risk is a risk that affects at most a small number of
assets, also called unique or asset – specific risk.
Total risk = Systematic risk + Unsystematic risk
(Nondiversifiable risk) (Diversifiable risk)
(Market risk) (Business-specific risk)
36
 RISK DIVERSIFICATION:
SYSTEMATIC AND UNSYSTEMATIC RISK

• When more and more securities are included in

a portfolio, the risk of individual securities in the
portfolio is reduced.
• This risk totally vanishes when the number of
securities is very large.
• But the risk represented by covariance remains.
• Risk has two parts:
1. Diversifiable (unsystematic)
2. Non-diversifiable (systematic)
37
 The Principal of Diversification
The principal states that spreading an investment across a
number of assets will eliminate some, but not all, of the risk.

Unsystematic risk is essentially eliminated by diversification,

so a portfolio with many assets has almost no unsystematic
risk. In other words, systematic risk is not eliminated by
diversification, and this risk is measured by beta.

Total risk of an investment is measured by the standard

deviation of its return.
38
 Systematic Risk

• Systematic risk arises on account of the

economy-wide uncertainties and the tendency
of individual securities to move together with
changes in the market.
• This part of risk cannot be reduced through
diversification.
• It is also known as market risk.
• Investors are exposed to market risk even when
they hold well-diversified portfolios of securities.
39
Examples of Systematic Risk

40
 Unsystematic Risk
• Unsystematic risk arises from the unique
uncertainties of individual securities.
• It is also called unique risk.
• These uncertainties are diversifiable if a large
numbers of securities are combined to form well-
diversified portfolios.
• Uncertainties of individual securities in a portfolio
cancel out each other.
• Unsystematic risk can be totally reduced through
diversification.
41
Examples of Unsystematic Risk

42
Total Risk

43
Systematic and unsystematic risk and
number of securities

44
 Systematic Risk and Beta
The systematic principle states that the reward for bearing risk depends
only on the systematic risk of an investment. In other words, the
expected return on a risky assets depends only on that asset’s
systematic risk.

Measuring Systematic Risk

This is measured by beta coefficient or simply beta (β ). It tells how
much systematic risk a particular asset has relative to an average asset.
By definition: an average asset has a beta of 1.0 relative itself.
So, an asset with a beta of 0.5 has half as much systematic risk as an
average asset. An asset with a beta of 2.0 has twice as much.
Note that the expected return, and thus the risk premium on an asset
depends on its systematic risk. Thus, the larger the beta, the greater
systematic risks, and then greater expected returns.
45
 Example of US Stock Companies
From the Table 5 below, an investor who buys Exxon which has a
beta of 0.5 should expect to earn less on average than an investor
who buys stock in General Motors which has a beta of 1.15.

Beta Coefficient (β)

Exxon 0.65
AT&T 0.90
IBM 0.95
Wal-Mart 1.10
General Motors 1.15
Microsoft 1.30
Harley-Davidson 1.65
America Online 2.40

46
 An example in Table 6
Standard deviation Beta
Security A 40% 0.50
Security B 20 1.5

Given the information above,

which has greater total risk?
Which has greater systematic risk?
Which asset will have a higher risk premium?

47
Beta Estimation

48
 Portfolio Betas
Portfolio beta is the summation attained by multiplying each asset’s beta
by its portfolio weight. It is calculated like the expected portfolio return.
Looking in Table 6, suppose you invest half of your money in AT&T and
an half in General Motors. What would the beta of the combination be?
Solution: βp = 0.50 x βAT&T + 0.5 x βGM
= 0.50 x 0.90 +0.50 x 1.15
= 1.025.
So, Portfolio beta = Σ Wi * βi
Where: Wi = proportion of an asset in the portfolio,
βi = beta of the asset.

49
 Class Work in Table 7
• Given the following investment information perform the following
questions.
• What are return and beta of this portfolio?
• Does this portfolio have more or less systematic risk than the average
asset?
Ans: 14.9% vs 1.16; Because beta is larger than 1, then the portfolio has
greater systematic risk than an average asset.

Security Amount Expected Beta

Invested Return
Stock A $ 1,000 8% 0.80
Stock B 2,000 12 0.95
Stock C 3,000 15 1.10
Stock D 4,000 18 1.40

50
 Beta and Risk Premium
Note that a risk free by definition has no systematic risk or
unsystematic risk. So, it has a beta of zero.
Remember that we can calculate the expected portfolio return
and beta given the mix of an asset and risk free.
Suppose an asset A has expected return of 20%, beta 1.6, risk
free 8%. If 25% of portfolio is invested in asset A, then the
expected portfolio returns are 11% and 0.4 for beta.
Note that, when you mix an investment asset with a free asset
investment, it is possible for the % invested to exceed 100%.
Suppose an investor has $100 and borrows an addition of $50
at 8%, the risk free rate. Then, the total investment in a
particular asset say A is $150, or 150% of the investor’s wealth.
So, the portfolio return and beta can be calculated as follows:51
 Beta and Risk Premium

E(Rp)= 1.50 x E(RA) + (1- 1.50) x Rf

= 1.5x20% + (1-1.5)x8% = 26%
βp = 1.50 x βA + (1- 1.50) x Rf
=1.5x1.6 + (1-1.5) x 0 = 2.4
Table 8: We can calculate other possibilities, as follows:
% of Port. in Portfolio Portfolio Beta
Asset A Expected Return
%
0 8 0
25 11 0.4
50 14 0.8
75 17 1.2
100 20 1.6
125 23 2.0
150 26 2.4
52
 Beta and Risk Premium

From the above data we can determine the Reward-To-Risk Ratio which is
the slope of the straight line of the Portfolio Expected return against Portfolio
Beta. Note that the slope is just the risk premium on Asset A.
Slope = (E(RA) – Rf)/ βA = (20% - 8%) / 1.6 =7.5%.
The result tells us that asset A offers a reward-to-risk ratio of 7.5%. In other
words, asset A has a risk premium of 7.50 percent per unit of systematic risk.
The Basic Argument:
Suppose we consider a second asset, asset B with beta of 1.2 and expected
return of 16%. Which investment is better btn A or B? You can get the
answer based on reward to risk ratio.
Eg. If we put 25% in asset B and remaining 75% in risk free asset, then
portfolio return and beta will be 10% vs 0.30. Then, adopt the previous
example in Table 7.
Slope = (E(RA) – Rf)/ βA = (16% - 8%) / 1.2 = 6.67%.
53
 Beta and Risk Premium
Note that, the comparison for asset A and B depends on the whether they
are subjected in the same situation. In other words, they could bear the
same results if they are in situation of active, competitive, and well
functioning markets. In that situation slopes are the same.
Slope = (E(RA) – Rf)/ βA = (E(RA) – Rf)/ βA :
This mean that reward-to-risk ratio must be the same for all the assets in the
market.

Overvalued vs Undervalued Asset

If a security provides expected return in excess of that required by the
market – it will be undervalued in the market. Thus, the security will be
attractive to investors. Otherwise the asset will be overvalued (below the
market line) and unattractive to investors who will ultimately sell it, and
those without it will avoid it.
54
COMBINING A RISK-FREE ASSET AND
A RISKY ASSET

55
A Risk-Free Asset and A Risky Asset:
Example
RISK-RETURN ANALYSIS FOR A PORTFOLIO OF A RISKY AND A RISK-FREE SECURITIES

Weights (%) Expected Return, R p Standard Deviation (p)

Risky security Risk-free security (%) (%)

120 – 20 17 7.2
100 0 15 6.0
80 20 13 4.8
60 40 11 3.6
40 60 9 2.4
20 80 7 1.2
0 100 5 0.0

20
Expected Return

D
17.5
C
15
B
12.5
10 A
7.5
5
2.5 Rf, risk-free rate

0
0 1.8 3.6 5.4 7.2 9
Standard Deviation

56
 The Security Market Line (SML)

Is the line that describe the relationship between systematic risk and
expected return in financial markets. In other words, is a positively sloped
straight line displaying the relationship between expected return and beta.
That is the relation is said to be linear.
Market Portfolio:
Suppose we consider a portfolio made up of all the assets in the market,
such portfolio is called a market portfolio.
Because all the assets in the market must plot on the SML, so the market
portfolio must be made of those assets. To determine where it plots on SML
we need to know beta of the market portfolio (βM) which must have the
systematic risk of 1 or beta 1. The slope of the SML can be expressed as:
SML slope = (E(RM) – Rf)/ βM = (E(RM) – Rf)/ 1: = E(RM) – Rf
The term E(RM) – Rf is often called the Market risk premium because it is
the risk premium on a market portfolio. 57
 The Capital Asset Pricing Model (CAPM)
This model hold an assumption that any asset on the market must
plot/lie on the SML and the reward-to-risk ratio is the same as the
overall market is. That is, slope of any asset in the market can be
compared to return of the market.
Slope = (E(Ri) – Rf)/ βi = (E(RM) – Rf): By arranging

(E(Ri)) = Rf + [(E(RM) – Rf)] x βi.

Thus, the result is what is called CAPM, which is the equation that
shows the relationship between expected return and beta. Basically,
the equation shows that CAPM depends on
1. The pure time value of money = Rf ,
2. The reward for bearing systematic risk. (E(RM) – Rf).
3. The amount of systematic risk. βi
58
 Implications
• Investors will always combine a risk-free asset with
a market portfolio of risky assets. They will invest
in risky assets in proportion to their market value.

• Investors will be compensated only for that risk

which they cannot diversify.

• Investors can expect returns from their investment

according to the risk.
59
 Limitations
It is based on unrealistic assumptions.
 It is difficult to test the validity of CAPM.
 Betas do not remain stable over time.

60
 Arbitrage Pricing Theory (APT)
APT involves factor model approach. Unlike CAPM, which is single factor
model that entails only beta, Factor Models suggest that the security returns
are generated by a set of underlying factors, often economic. APT or Roll-
Ross Model suggest that different securities have different sensitivity of these
systematic factors and that the major sources of security are captured in
them. Five factors considered are
1) Changes in expected inflation
2) Unanticipated changes in inflation
3) Unanticipated changes in industrial production
4) Unanticipated changes in the yield differential between low and high
grade bonds
5) Unanticipated changes in the yield differential between long-term and
short-term bonds
61
 Arbitrage Pricing Theory (APT) cont..
• The Roll-Ross Model can be expressed as:
• (E)R = 0 + 1(b1jE inflation) + 2(b2jU
inflation) + 3(b3jU industrial production) +
4(b4jU bond risk premium) + 5(b5jU long
minus short rate).
• Where s is the market prices of various risks,
1 is the response coefficients for specific
security returns to changes in the factor.
62
 Examples
1) XY company has a beta of 1.25. The risk free rate is 8% and
expected return on the market portfolio is 15%. What is the
expected return using CAPM without extension? Ans 16.75%

2) Return on Z’s stock is related to factors 1 and 2 as follows:

E(R) = 0 + 0.61 + 1.32
where 0.6 and 1.3 are sensitivity or reaction, coefficients associated with
each of the factors. If the risk free rate 7%, 1 the is 6% 2 is 3%, what
is Z’s expected return?

Soln E(R) = 0.07 + 0.6*0.06 + 1.3*0.03 = 14.5%

63
 Examples cont…
• Suppose a three factor APT model holds and the risk free rate is 6%.
There are two stocks in which you have a particular interest ML and
BE enterprises. The market price lambdas and reaction coefficients
for the two stocks are as follows:
Factor  ML BE
1 0.09 0.5 0.7
2 -0.03 0.4 0.8
3 0.04 1.2 0.2
• What would be the expected return on your portfolio if you were to
invest (a) equally in the two securities (b) one third in ML and remain
in BE? E(R) ML = 14.1%, BE = 10.7%, (a) = 12.4% (b) = 11.83%.

64