Description
FIN 500: Case Study
1 Assignment
Notes
Your first case assignment deals with the concepts of
risk and return. Please read the case questions through and give some thought
to your answers before you commence. Answer all parts of the ten (10) questions
presented below. Your report should be wellorganized, typewritten/word
processed, and independently prepared. Each student’s report must
be his/her own original work and the writeup must also be individually
prepared.
1.
Buxton Corporation is planning to invest in a security
that has several potential rates of return. Using the following probability
distribution of returns during different states of the economy, what is the
expected rate of return on this investment? In addition, compute the standard
deviation of the returns (?). Finally, briefly explain what these numbers
represent.
Probability 
Expected Return 
0.10 
10% 
0.20 
5% 
0.30 
10% 
0.40 
25% 
2.
Using the capital asset pricing model (CAPM), estimate
the appropriate required rate of return for the following three stocks,
assuming that the riskfree rate (r_{RF}) is 5 percent and the expected
return for the market (r_{M}) is 17 percent.
Stock 
Beta (?) 
A 
0.75 
B 
0.90 
C 
1.40 
3.
Based on the following table of actual (or ex post)
returns for both Inquiry Corporation and the market from 2007 through 2010,
calculate the average return and the standard deviation for both Inquiry and
the market (keep in mind that this data is historical and not based on a
probability distribution, so be sure to use the correct formulas).
Year 
Inquiry Corporation 
Market 
2007 
4% 
2% 
2008 
6% 
3% 
2009 
0% 
1% 
2010 
2% 
1% 
4.
(a)
Derive the expected return (r_{P}) and beta (?_{P})
for a portfolio based on the following information:
Stock 
Percentage of Portfolio 
Beta (?) 
Expected Return 
1 
40% 
1.00 
12% 
2 
25% 
0.75 
11% 
3 
35% 
1.30 
15% 
(b)
Given the information in the table above, present the
equation for the security market line and explain where the return for this
specific portfolio would lie (plot) relative to the SML (i.e., below or above
the line). Assume that the riskfree rate (r_{RF}) is 8 percent and
that the expected return on the market portfolio (r_{M}) is 12 percent.
5.
Reliable Printing is evaluating a security. Oneyear
Treasury bills (r_{RF}) are currently paying 3.1 percent. Calculate the
following investmentâ€™s expected return and its standard deviation (?). Should
Reliable Printing invest in this security? Briefly explain.
Probability 
Expected Return 
0.15 
1% 
0.30 
2% 
0.40 
3% 
0.15 
8% 
6.
You have researched the common stock of two companies (A
and B) and have compiled the following information:
COMPANY
A COMPANY
B
Probability 
Return 
Probability 
Return 
0.20 
2% 
0.10 
4% 
0.50 
18% 
0.30 
6% 
0.30 
27% 
0.40 
10% 


0.20 
15% 
Calculate the
expected return, standard deviation (?), and the coefficient of variation (CV)
for each stock and, based on the CV, which stock should you invest in? Briefly
explain.
7.
Assume you own a portfolio consisting of the following
stocks:
Stock 
Percentage of Portfolio 
Beta (?) 
Expected Return 
1 
20% 
1.00 
16% 
2 
30% 
0.85 
14% 
3 
15% 
1.20 
20% 
4 
25% 
0.60 
12% 
5 
10% 
1.60 
24% 
(a) Determine
the expected return on your portfolio.
(b) Determine
the portfolio beta (?_{P}).
(c) Given
the portfolio beta and the assumptions that the riskfree rate (r_{RF})
is 7 percent and the expected return on the market portfolio (r_{MKT})
is 15.5 percent, present the equation for the security market line (SML).
(d) Based
on your equation for the SML and the expected returns from the data in the
table, which stocks appear to be winners (i.e., underpriced) and which stocks
appear to be losers (i.e., overpriced)?
8.
The common stock for a particular company is known to
have a beta (?) of 1.20. The expected return on the market (r_{M}) is 9
percent and the riskfree rate (r_{RF}) is 5 percent.
(a) Compute
a fair rate of return based on this information.
(b) What
would be a fair rate of return if the beta were 0.85?
(c) What
would be a fair rate of return if the expected return on the market increased
to 12 percent and the beta remained at 0.85?
9.
The expected return for the general market (r_{MKT})
is 12.8 percent, and the market risk premium (i.e., RP_{M}) is 4.3
percent. Moe, Larry, and Curley have betas of 0.82, 0.57, and 0.68,
respectively. What are the required rates of return for the three securities?
10. Hickory
Stickâ€™s common stock has a beta (?) of 0.95. The expected return for the market
(r_{M}) is 7 percent and the riskfree rate (r_{RF}) is 4
percent.th
(a) What
is the required rate of return based on this information?
(b) What
would be the required rate of return if the beta were 1.25?
11. An
exhaustive financial analysis has produced the following returns on two
investments under three different scenarios:
Expected
Returns
Scenario 
Probability 
Stock X 
Stock Y 
S_{1} 
0.3 
10% 
8% 
S_{2} 
0.4 
16% 
15% 
S_{3} 
0.3 
12% 
20% 
(a) Calculate
the expected return on each investment.
(b) Calculate
the standard deviations (?) for both X and Y.
(c) Calculate
the coefficient of variation (CV) for both X and Y.
(d) If
you were to create a portfolio consisting of 67% of Stock X and 33% of Stock Y,
what will be the expected return (r_{P}) and the standard deviation (?_{P})
for your portfolio?
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