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# Strategic management - Essay Example

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(e) With reference to the results of parts (a) to (d), explain briefly how the correlation between the returns on individual securities affects the gain (in terms of reduction in risk) available to an investor who is willing to construct a diversified portfolio.
When there is…

## Extract of sample "Strategic management"

Download file to see previous pages The lower correlation value of securities in portfolio means lower list. Correlation can vary between -1 to +1.
(Ri, RM) denotes the correlation between the returns on security i and the returns on the market portfolio; (Ri) denotes the standard deviation of the returns on security i, E(RM) denotes the expected return on the market portfolio; (RM) denotes the standard deviation of the returns on the market portfolio; and RF denotes the risk-free rate of return.
(c) Write down an expression for the security market line. Draw a sketch of the security market line, and indicate the positions of securities A and B on this line. Explain briefly how you would interpret the security market line.
The risk free rate of returns is 4%. Beyond that, the higher the risk, higher the returns. In the above Security Market Line, Security A gives 4.5% returns at 10% risk. Security B gives 5.2% returns at 20% risk. The slope of the security market line is the risk(B-Beta).
(d) Write down expressions for the characteristic lines for securities A and B. Draw sketches of the characteristic lines for securities A and B. Explain briefly how you would interpret the characteristic lines.
The systematic risk is common for all the securities in the market. So, the systematic risk is common for the securities A and C too. The unsystematic risk is unique to each and every security. The risk of Securities A and C are 6% and 11% respectively. The systematic risk has to be less than 6%. Assuming that systematic risk is x %, the unsystematic risk for security A would be 6%-x% and for Security C would be 11%-x%. Since 11%-x% would be greater than 6%-x%, the Security C has higher risk compared to Security A.
Roll questioned whether it is even conceptually possible to test the CAPM. Roll showed that the linear relationship which prior researchers had observed in graphs ...Download file to see next pagesRead More
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