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FIN 500: Case Study 1 Assignment




Question;Your first case assignment deals with the concepts of risk and return. Please read thecase 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, type-written/word processed, and independently prepared. Each student'sreport must be his/her own original work and the write-up must also be individuallyprepared.1.Buxton Corporation is planning to invest in a security that has several potential rates ofreturn. Using the following probability distribution of returns during different states ofthe economy, what is the expected rate of return on this investment? In addition,compute the standard deviation of the returns (). Finally, briefly explain what thesenumbers represent.Probability0.100.200.300.402.Expected Return-10%5%10%%Using the capital asset pricing model (CAPM), estimate the appropriate required rate ofreturn for the following three stocks, assuming that the risk-free rate (r RF) is 5 percentand the expected return for the market (rM) is 17 percent.StockABC3.Based on the following table of actual (or ex post) returns for both Inquiry Corporationand the market from 2007 through 2010, calculate the average return and the standarddeviation for both Inquiry and the market (keep in mind that this data is historical andnot based on a probability distribution, so be sure to use the correct formulas).Year20072008200920104.Beta ()0.750.901.40Inquiry Corporation4%6%0%2%Market2%3%1%-1%(a)Derive the expected return (rP) and beta (P) for a portfolio based on thefollowing information:StockPercentage ofPortfolio40%%35%123(b)5.Beta ()1.000.751.30ExpectedReturn12%11%15%Given the information in the table above, present the equation for the securitymarket 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 (r M) is 12percent.Reliable Printing is evaluating a security. One-year Treasury bills (r RF) are currentlypaying 3.1 percent. Calculate the following investments expected return and itsstandard deviation (). Should Reliable Printing invest in this security? Briefly explain.Probability0.150.300.400.15Expected Return-1%2%3%8%6. You have researched the common stock of two companies (A and B) and havecompiled the following information:COMPANY AProbability0.200.500.30COMPANY BReturnProbability-2%0.1018%0.3027%0.400.20Return4%6%10%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? Brieflyexplain.7. Assume you own a portfolio consisting of the following stocks:Stock123Percentage ofPortfolio20%30%15%Beta ()1.000.851.20ExpectedReturn16%14 %4525%10%0.601.6012%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 (r RF) is 7 percentand the expected return on the market portfolio (rMKT) is 15.5 percent, present theequation for the security market line (SML).(d) Based on your equation for the SML and the expected returns from the data in thetable, which stocks appear to be winners (i.e., underpriced) and which stocksappear to be losers (i.e., overpriced)?8.The common stock for a particular company is known to have a beta () of 1.20. Theexpected 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 to12 percent and the beta remained at 0.85?9.The expected return for the general market (rMKT) is 12.8 percent, and the market riskpremium (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 Sticks common stock has a beta () of 0.95. The expected return for themarket (rM) is 7 percent and the risk-free rate (rRF) is 4 percent.(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 investmentsunder three different scenarios:ScenarioS1S2S3Expected ReturnsProbability0.30.40.3Stock X10%16%12%Stock Y8%15 %(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 yourportfolio?


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