LANCASTER UNIVERSITY
Management School
Department of Accounting and Finance
AcF 215: Advanced Principles of Finance
Lent Term 2018
Problem Solving Workshop Week 15
Exercise 1
Look at the diagram below depicting the returns, standard deviation of returns and β’s
of four assets A, B, C and D
Assets A, B, C and D all have the same expected return but different risk, how is this
possible
Exercise 2
The following data were collected for Lune plc
Year Market return Return Company
2007 0.27 0.25
2006 0.12 0.05
2005 -0.03 -0.05
2004 0.12 0.15
2003 -0.03 -0.10
2002 0.27 0.30 1
Assume that the risk-free rate is currently 5% and is expected to remain at this point
for the foreseeable future. Calculate the following:
a) The expected market return.
b) The variance of the market return.
c) The expected rate of return for Lune plc.
d) The covariance of the return of Lune plc with the return on the market
e) Write the equation of the security market line.
f) What is the required return for Lune plc.
Note: The variance and covariance of two random variables X and Y are given by
