- 20 Marks
FM – May 2021 – L3 – Q6 – Portfolio Management
Evaluate Tico Plc’s share price using CAPM, identify potential errors in valuation, and discuss limitations of portfolio theory in physical investment decisions.
Question
Tico Plc is comprised of only four major investment projects, details of which are as follows:
| Project | % of Company Market Value | Annual % Return During Last 5 Years | Risk % Standard Deviation | Correlation with the Market |
|---|---|---|---|---|
| 1 | 28 | 10 | 15 | 0.55 |
| 2 | 17 | 18 | 20 | 0.75 |
| 3 | 31 | 15 | 14 | 0.84 |
| 4 | 24 | 13 | 18 | 0.62 |
The risk-free rate is expected to be 5% per year, the market return 14% per year, and the standard deviation of market returns 13%.
Required:
a. Assume that Tico Plc’s shares are currently priced based upon the assumption that the last five years’ experience of returns will continue for the foreseeable future. Evaluate whether or not the share price of Tico Plc is undervalued or overvalued. (8 Marks)
b. Discuss why your results in (a) above might not correctly identify whether or not the share price of Tico Plc is undervalued or overvalued. (6 Marks)
c. Briefly discuss the key limitations of portfolio theory in the analysis of physical investment decisions in practice. (6 Marks)
Find Related Questions by Tags, levels, etc.
- Tags: CAPM, Market Valuation, Portfolio Theory, Risk-Return Tradeoff
- Level: Level 3
- Topic: Portfolio Management