Financial Theory & Analysis

UNIVERSITY OF BOTSWANA
FACULTY OF BUSINESS
DEPARTMENT OF ACCOUNTING & ACCOUNTING
TEST 2
FRONT PAGE
COURSE NO: FIN 400 DATE: November 2021
TITLE OF THE PAPER: FINANCIAL THEORY & ANALYSIS
SUBJECT: FINANCE DURATION: 1 HR
INSTRUCTIONS:
1. There are Eight (8) Questions. ANSWER ALL
2. The question paper carries a total of 40 marks
3. Neatness and presentation will be considered in grading.
4. Show all the supporting work & Formulae
5. Give your answers to 2 decimal places where appropriate.
6. Be brief and to the point. Write in point form where possible.
7. Possession of unauthorised material is strictly prohibited.
DO NOT OPEN THIS PAPER UNTIL YOU ARE TOLD TO DO SO BY THE SUPERVISOR/INVIGILATOR
No. of Pages 4 (Including Cover Page)

1. Given a risk free asset and portfolio M, present the formula for calculating a two asset
portfolio return and also demonstrate how to arrive at portfolio risk (standard
deviation) which is given by p = m . (7 marks)
Rp = E[Rm] + (1 - )Rf (2 marks)
p2 = 2VAR[Rm]+ (1- )2VAR[Rf]+ 2(1- )COV[Rm,Rf]
= 2VAR[Rm]+ (1- )20+ 2(1- )0 = 2VAR[Rm]
p = m (5 marks)
2. Differentiate between the Capital Market Line (CML) and Security Market Line
(SML). (4 marks)
The CML is sometimes confused with the security market line (SML). The SML is
derived from the CML. While the CML shows the rates of return for a specific
portfolio, the SML represents the market’s risk and return at a given time, and shows
the expected returns of individual assets. And while the measure of risk in the CML
is the standard deviation of returns (total risk), the risk measure in the SML
is systematic risk or beta. (4 marks)
3. With the help of relevant formulae, demonstrate why beta of a risk free security is
zero and that of a market portfolio is 1. (6 marks)
Risk free Security
Beta for risk-free asset is zero because its covariance with market portfolio is zero
The numerator of the above function is zero because Since COV(Rf, Rm)= QfQmRf,m=
0*QmRf,m = 0
Market Portfolio
Beta for market portfolio is 1 because the covariance of market portfolio with itself is
identical to the variance of the market portfolio.
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