Faculty of Economics and Business
Department of Business
FINANCE I (102329) – Group 3 – 2012-13
Study Guide. Dr. Maria-Antonia Tarrazon & Dr. Joan Montllor
1
EXERCISE 5: THE TRIBE OF THE REVELRY-AND-SPREE1
Exercise to check your knowledge about the CML and the SML
Professor Snaporaz did not understand Chris Crash’s insistence to accompany her, the famous explorer, in
her journey to the Paparines Islands to study the habits of the tribe of the Reverly-and-Spree until he found
himself into the core of the Miko-Coco forest, where the Revelry-and-Spree people live.
“This is a strange and original tribe, dear professor”, said Chris. “In the Miko-Coco forest there are two
firms known as GranCacao (GC) and Cocos-Kiko (CK). All the Revelry-and-Spree people agree about the
following parameters”:
Expected return E(Rj)
Standard deviation (j)
GC corr
CK corr
GranCacao (GC)
30%
12%
1
0.10
Cocos-Kiko (CK)
15%
12%
0.10
1
Risk-free asset
5%
“I have also noticed”, added Chris, “that they have the amazing habit of investing their savings with the
following weights: 76.19% in stocks of GranCacao and 23.81% in stocks of Cocos-Kiko, a combination that
they call the market portfolio, with an expected return of 26.43% and a standard deviation of 9.8478%.
Some of them prefer to reduce their investment in the market portfolio to lend their savings at 5%, while
others increase their investment in the market portfolio borrowing additional funds also at 5%”.
“Now I would like to ask you, dear professor”, said Chris, “to help me in my research about the Revelry-
and-Spree people answering the following questions, all of them of great importance to my scientific
research”:
1. Which are the equations that they name the Capital Market Line and the Security Market Line? How do
their diagrams look like?
2. Quite often they speak about the coefficients beta of GranCacao and Cocos-Kiko. Which is their
meaning? Which are their values? And which is their relationship with the coefficient beta of the market
portfolio?
3. Why do the rates of return on the stocks of these two firms only take into account part of their risk?
How is this type of risk called? Which are their values for the two firms operating in the Miko-Coco forest?
And their relationship with the standard deviation of the market portfolio?
4. There is a small minority of the Revelry-and-Spree people who invest only in stocks of Cocos-Kiko. Which
is the required rate of return on these stocks that they have to ask for? Why?
5. And finally, another question concerning the firm Cocos-Kiko: Is it true that this company is inefficient
since this investment is clearly dominated by GranCacao? Would it be better to suppress this firm?”
Question: Please answer the questions that the famous explorer Chris Crash addressed to Professor
Snaporaz.
1 In Catalan known as “la Tribu dels Vinga-Sarau”.
