QUESTION ONE

Part A

Expected Gross Return:

Total Expenses:
20,000×0.015=300

Net Return:
1,400−300=1,100

Part B

Sharpe Ratio = (Rp - Rf) / σ

The Sharpe Ratio of 0.5 indicates that the portfolio offers a return that is 0.5 times the standard
deviation of its excess return over the risk-free rate, which reflects a moderate risk-adjusted
return. A higher Sharpe Ratio generally suggests a better risk-adjusted performance.

Part C

Net Asset Value (NAV) represents the per-share value of a mutual fund, calculated by taking the
total assets of the fund, subtracting its liabilities, and dividing by the number of outstanding
shares. The formula for NAV is:
NAV=(Total Assets - Total Liabilities)/Number of Shares Outstanding

NAV exhibits the value of the fund at a given period as well as the price at which the securities
held by the fund are valued. NAV is calculated at the end of each business day after the market
closes, due to the fact mutual funds prices are other than intraday, like stocks. This results in
mutual funds being able to present current value of its share through adjustment of the shares’
value in line with the daily market performance for prospective evaluation by its investors.

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Part D

It’s important for mutual fund investors to comprehend NAV since it determines the price
investors pay or receive for the shares of the fund. NAV therefore gives a fund investor the
ability to track how it is faring over time depending on its per share value. In this case, this
metric assist investors to assess the geographical distribution and the total asset of the fund. NAV
also reflects daily portfolio changes and gives a picture of fund growth or reduction in the most
recent period. An increase in NAV may be a sign of enhancement in the value of the assets held
by the mutual fund while a fall in NAV shows depreciation in the value of those assets. Thus,
NAV is a valuable tool for investors making decisions with the help of the fund information in
terms of present outcomes and the current market.

Part E

NAV is a good reference tool used by investors to establish the per-share price of a fund before
investing into it. While NAV does not tell the investment dealers whether the fund is inexpensive
or expensive, following NAV from time to time will assist in working out whether the given fund
is experiencing gains or losses. Also, finding out the movement in NAV shows investors the
record performance and fluctuation of the fund. These results will show that the NAV is
increasing steadily which would indicate efficient management of the funds as well as profitable
investment of those assets and that is why investors are impressed. On the other hand, a decline
in the NAV may well be suggesting poor performance. Therefore, analyzing NAV trends helps
investors to select relevant funds to suite their desired investing objectives and risk appetite
level.

QUESTION TWO

Expected Return = Sum (Probability × Return)

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 0.20 0.00 -0.10 -0.05
Calculating the expected return for each stock:
Stock 1
E(R_1) = (0.25 × 0.20) + (0.35 × -0.05) + (0.20 × 0.10) + (0.20 × 0)
E(R_1) = 0.05 - 0.0175 + 0.02 + 0
E(R_1) = 0.0525 (or 5.25%)
Stock 2
E(R_2) = (0.25 × 0.25) + (0.35 × 0.10) + (0.20 × 0.05) + (0.20 × -0.10)
E(R_2) = 0.0625 + 0.035 - 0.01
E(R_2) = 0.0875 (or 8.75%)
Stock 3
E(R_3) = (0.25 × 0.10) + (0.35 × 0.05) + (0.20 × 0) + (0.20 × -0.05)
E(R_3) = 0.025 + 0.0175 - 0.01
E(R_3) = 0.0325 (or 3.25%)
Recommendation
According to the estimation, Stock 2 has a better expected return of 8.75% while Stock 1 has
second highest expected return of 5.25 %. Stock 3 has the lowest expected return and is 3.25%.
While considering the attached risks, we consider the returns during the lowest performers
market conditions. We see Stock 2 has suffered a very slight of -0.10 in one case but preserves
the positive return in others which suggests high expected return even with the risk. Both Stock 1
max loss comes at -0.05 and the information share the same risk profile and present the expected
returns. On the other hand, Stock 3 indicates negative figures to be the highest at -0.10
influencing enhanced overall risk. From the aforesaid evaluations, it is advised to include stock 2
and stock 1 in a portfolio. The reason for preferring stock 2 is because of its higher value of
expected return which will be relatively rewarding the associated risk. They balance the portfolio
because Stock 1 has a good expected return and has similar risk to Stock 2, meaning it works
well in filling in the gaps in the portfolio.

QUESTION THREE
The Beta coefficient of an asset is an elementary measure in financial analysis and is normally
used to compare with the market risks. In the context of the Capital Asset Pricing Model
(CAPM) the Beta comprises information reflecting how much an investment’s return deviates

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from the market return due to overall market movements. This measure is useful in risk analysis
since it calculates systematic risk, risk associated with whole market or part of it while excluding
idiosyncratic risk or risk specific to an individual asset (Bali et al., 2017). This background
means that an understanding of Beta is valuable in the assessment of asset performance in
different market conditions and so, serves as an important tool in portfolio construction and
management of risk. In other words, if the Beta is 1 this tells us that the asset is perfectly
correlated to the market. So, an asset with a Beta of 1 is expected to give 1% gain if the market
gains 1%. Conversely, Beta that is greater than 1 mean that the asset moves more than the
market; for example, a Beta of 1.5 mean that the asset is expected to move 1.5% for every 1%
move of the market, thus heightening market movements. A Beta less than 1, on the other hand
suggests that the volatility of the asset is less than that of the market. For example, Beta of 0.8
implies that the asset will fluctuate by only 0.8% when the market fluctuates by 1% of its
original value (Hsu, Tsai, & Chiang, 2020). The value of the Beta coefficient is gotten from the
ratio of the product of the covariance between the return of the asset and return of the market to
the variance of the return of the market. S

Covariance(Asset , Market )
Beta=
Variance(Market )

=0.03/0.02

=1.5

This signifies that Beta value that is 1.5 means the asset has 50% higher risk than the market.
While investors might prefer investing in such assets depending on their high rate of return
during bullish market, they may also depreciate in bear market hence the need to consider the
Beta when investing. Beta has a main application in evaluating the dispersion of the returns of
assets against the market. Based on the fact that Beta measures an asset’s movement to changes
in the market, investors can determine how much the return of the asset may; fluctuate in the
market. This is especially important to diversified portfolios, it is sometimes necessary to hedge
market risk with actual assets that can demonstrate different behavior from the market. For
instance, high-Beta stocks can mean higher return but with high risk as compared to low-Beta
assets that means that they are safer if the market is shrinking (Reilly & Brown, 2019).
Nevertheless, Beta has its drawbacks of measuring risk.

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One of the considerations is that it assumes the linearity between the asset’s return and the rate of
market returns, which may not always be the case when it comes under pressure of financial
crisis or transition matrix. This shortcoming is especially seen in the emerging markets or in the
periods of financial crisis, where the correlation with the market becomes unstable and thus the
Beta loses it relevance (Nguyen & Pham, 2018). Also, Beta just measures unsystematic risk in
relation to the market and fails to account for individual risks related to a particular company, its
sphere of operations or region. For example, that the stock of a technology firm which may have
a situation where, regulatory changes, this company’s price of its stock can move drastically to
such news regardless the state of market that is a risk that the Beta fails to consider (Bensoussan,
Chau, & Tapiero, 2019).

Another weakness of Beta is that it relies on historical information trailing and this may prove
less reliable with changes in performance for some of the assets that maybe highly risky. For
instance, if a firm experiences radical transformation in the industry, such as merger or
transformation in business model, Beta estimated from the past data cannot be expected to
indicate its future Beta (Fu et al., 2016). Also note, some high Beta stocks may not give you
those higher returns you expect especially during periods of market insanity which may be a
result of irrational behaviours that lead to unjustified fluctuations in price. Although Beta is an
important measure of an asset’s market risk linkages, on its own, it is not very useful. Beta
analysis is recommended to be used in conjunction with other measures of risk including, for
example, the standard deviation or Value at Risk (VaR). With the help of integrating Beta with
other different risk assessment tools, investors can get more effective information for the
formation of their portfolios and the level of tolerable risks in different kinds of markets,
including the unstable one.

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REFERENCES

Bali, T. G., Brown, S. J., & Caglayan, M. O. (2017). Systematic risk and the cross section of
hedge fund returns. Journal of Financial Economics, 126(1), 1-22.

Bensoussan, A., Chau, P., & Tapiero, C. S. (2019). Risk management in a volatile environment.
Springer.

Fu, F., Park, J., & Zeng, Y. (2016). Volatility, investor sentiment, and beta: A long-run
perspective. Journal of Financial Economics, 121(1), 142-163.

Hsu, J., Tsai, C., & Chiang, T. C. (2020). Return predictability and beta risk: Evidence from
developed and emerging markets. Journal of Financial Markets, 50, 100540.

Nguyen, Q. H., & Pham, L. T. (2018). Market beta instability in the emerging markets.
International Review of Financial Analysis, 55, 142-153.

Reilly, F. K., & Brown, K. C. (2019). Investment Analysis and Portfolio Management (11th ed.).
Cengage Learning.