Question

Loans classified by intended use include

Working capital loans
Unsecured loans
Secured loans
None of the above
Majority of the shareholders vote in the annual general meeting of a firm
In-person
By proxy
Do not vote
None of the above
The major drawback of the dividend growth model in estimating the cost of equity is
Excessive dependence on the quality of growth rate estimates
Simplicity
Using current market information
All the above

Answer 1

The Capital Market Line (CML) represents the set of efficient portfolios in the market, offering the highest expected return for a given level of risk. It is derived from the combination of the risk-free asset and the market portfolio. To calculate the CML, we need to find the optimal combination of the risk-free asset and the market portfolio.

Given the information:

- Weight of Security A in the market portfolio (WA) = 40%

- Weight of Security B in the market portfolio (WB) = 60%

- Expected return of Security A (RA) = 10%

- Expected return of Security B (RB) = 15%

- Standard deviation of Security A (σA) = 20%

- Standard deviation of Security B (σB) = 28%

- Correlation between the assets (ρ) = 0.3

- Risk-free rate (RF) = 5%

The expected return of the market portfolio (RM) can be calculated as the weighted average of the expected returns of the individual securities in the portfolio:

RM = WA * RA + WB * RB

RM = 0.4 * 10% + 0.6 * 15%

RM = 4% + 9%

RM = 13%

Next, we calculate the standard deviation of the market portfolio (σM) using the formula:

σM = √(WA^2 * σA^2 + WB^2 * σB^2 + 2 * WA * WB * ρ * σA * σB)

σM = √(0.4^2 * 0.2^2 + 0.6^2 * 0.28^2 + 2 * 0.4 * 0.6 * 0.3 * 0.2 * 0.28)

σM = √(0.016 + 0.062208 + 0.02016)

σM = √0.098368

σM ≈ 0.3138 or 31.38%

Now, we can calculate the expected excess return of the market portfolio (RM - RF):

Expected excess return = RM - RF = 13% - 5% = 8%

The slope of the CML, which represents the risk premium, is given by the formula:

Slope of CML = (RM - RF) / σM

Slope of CML = 8% / 0.3138 ≈ 0.2549

The y-intercept of the CML is the risk-free rate, so the equation of the CML is:

Expected return (E) = RF + Slope of CML * σ

E = 0.05 + 0.2549 * σ

Thus, the Capital Market Line for the given portfolio is E = 0.05 + 0.2549 * σ. This line represents the efficient portfolios that offer the highest expected return for each level of risk, and any portfolio lying above the CML is considered inefficient. Investors can use the CML to make informed decisions about their investment choices based on their risk tolerance and return objectives.