Question 1:
As a recent CUD graduate, Bloomberg Dubai found your cv interesting and appoints you as their market analyst. You are provided with the single index model result for Vodafone LLC stock. The S&P500 market index is used as the market proxy. The returns data are given, and the single index model result is as follows:
Returns Market Index
Vodafone S&P500
1-Jan-17 4.0% -2%
2-Jan-17 1.5% -4%
3-Jan-17 5.0% -6%
4-Jan-17 -2%
Coefficients
Alpha 0.0593
Beta 0.5214
Given a standard deviation of the error of 0.0201
A. If the S&P500 market index is expected to go change from 2500 to 2750, what is the expected return on the stock above? Show your workings. (1 mark)
B. Provide some clear justifications why you would use the single index model over the Markowitz model in determining the variables required to construct a client’s portfolio made up of 20 stocks? [2 marks]
C. Estimate Vodafone’s total risk (standard deviation) using the Single Index Model. [2 marks)
D. Evaluate the impact of Vodafone’s market-specific risk relative to the stock’s variance. (2marks]
E. You are looking into the construction of a portfolio, which will be made up of two stocks, namely Vodafone and Billabong (Ticker: BG). Given the beta of BBG is 0.65, and the standard deviation of BBG is 3%, calculate the correlation coefficient between the two cocks. [2 marks]
F. If you must decide between creating a portfolio made up of Vodafone and BBG based on the results in (e), and a portfolio made up of Vodafone and Yahoo which has a correlation coefficient of -0.75, which one would you recommend? Explain your answer. [2 marks)
G. if you want to construct a portfolio based on 50% Vodafone, 20% Billabong and the rest invested in a risk-tree asset, what would be the portfolio beta? Show your workings. (1.5 marks)
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