Chapter 7 • Portfolio theory and its relevance to real investment decisions
(Problems 7.1 to 7.4 are basic-level problems, whereas problem 7.5 is more advanced
and may contain some practical complications.)7.1*What sort of factors relating to a business specialising in operating ferries crossing the
English Channel would tend to give rise to (a) specific risk and (b) systematic risk?7.2 You have overheard the following statement: ‘If an investor holds shares in about 20
different businesses all of the risk is eliminated and the portfolio will give a return equal
to the risk-free rate.’
Is this statement correct? Explain.7.3 You have overheard the following statement: ‘According to portfolio theory, shares are
priced on the basis of their systematic riskiness. This means, therefore, that a piece of
bad news relating only to a particular business will not affect the market price of that
business’s shares.’
Is this statement correct? Explain.7.4 ‘Recently, equity returns have been lower than the returns available from short-term
government securities. Clearly, in such a period, the capital asset pricing model doesn’t
work because equity returns are supposed to be more than the risk-free rate.’
Is this statement correct? Explain.7.5*The following are the annual returns for the ordinary shares of Court plc and for a rep-
resentative equity price index:Year Court plc Index
%%
119 13
2 (8) (7)
3 (12) (13)
43 4
58 8
617 10
714 15
814 16
914 16
10 1 (2)(a) What is the beta for Court plc’s ordinary shares?
(b) If the risk-free rate is 6 per cent p.a. and the expected return for equities generally was
12 per cent p.a., what would be the expected return on Court plc’s ordinary shares?PROBLEMS
Sample answers to
problems marked with
an asterisk appear in
Appendix 4.There are sets of multiple-choice questionsand missing-word questions
available on the website. These specifically cover the material contained in this
chapter. These can be attempted and graded (with feedback) online.
There are also three additional problems, with solutions, that relate to the material
covered in this chapter.
Go to http://www.pearsoned.co.uk/atrillmclaneyand follow the links.‘