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Everest University FIN 500: Case Study 1 Assignment




Question;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 well-organized, type-written/word;processed, and independently prepared. Each student's report must;be his/her own original work and the write-up 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 risk-free rate (rRF) is 5 percent and the expected;return for the market (rM) 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 (rP) 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 risk-free rate (rRF) is 8 percent and;that the expected return on the market portfolio (rM) is 12 percent.;5.;Reliable Printing is evaluating a security. One-year;Treasury bills (rRF) are currently paying 3.1 percent. Calculate the;following investment?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 risk-free rate (rRF);is 7 percent and the expected return on the market portfolio (rMKT);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 (rM) is 9;percent and the risk-free rate (rRF) 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 (rMKT);is 12.8 percent, and the market risk premium (i.e., RPM) 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;Stick?s common stock has a beta (?) of 0.95. The expected return for the market;(rM) is 7 percent and the risk-free rate (rRF) is 4;;(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;S1;0.3;10%;8%;S2;0.4;16%;15%;S3;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 (rP) and the standard deviation (?P);for your portfolio?


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