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FINANCE Case 13- Mid-Atlantic Specialty, Inc. Solution Paper

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Question;MID-ATLANTICSPECIALTY,INC.FinancialRisk1. Compare the stand-alone risk/return of each of the five investment alternatives listed in Exhibit13.1.2. MSI is considering two investment strategies:-50percentinProjectAand50percentinProjectB(PortfolioA/B) or-50percentinProjectAand50percentintheS&P500Fund(PortfolioA/S&P). Comparethe riskofthetwoportfolios.Whydoestheriskdiffer?3.a.b.Comparethe corporateriskofProjectsAandB.(Hint:UsetheexpectedreturnsinExhibit13.1to createagraphwithcorporatecharacteristiclinesforProjectsAand B.Regressionlinescanbe createdusingthe=INTERCEPTand=SLOPEfunctionsinExcel.TheXY(Scatter)chartinExcelis recommended.)Whatwouldhappento theoverallriskofMSIifitinvestsinProjectA?ProjectB?4.a.b. c.Comparethe marketriskofa1-yearT-Bill,ProjectA,ProjectB,andequityinMSI.(Hint:UsethehistoricalreturnsinExhibit13.2tocreateagraphwith marketcharacteristiclinesfora1-yearT-Bill, ProjectA,ProjectB,andequityinMSI.)Whatwouldhappento theoverallriskofawell-diversifiedportfoliowithaninvestmentina1-YearT-Bill?ProjectA?ProjectB?EquityinMSI?Whatdoesthedistancebetweenthemarketcharacteristicslineand theexpected returnofan investmentindicate?5.a.b.Ifyouwereanindividualinvestorwithawell-diversifiedportfolio,whichinvestment(s)inExhibit13.1 wouldyoubuy?Why?(Inreality,MSIisanot-for-profitcorporation,soitwouldbeimpossible tobuy anequityinterestin thefirm.Forthisquestion,assumethatMSIisan investor-ownedcompany.) (Hint:constructaSecurityMarketLinegraphandplottheexpected returnofeachinvestmentonthegraph.)WhatdoesthedistancebetweentheSMLandtheexpectedreturnofaninvestmentindicate?6.a. b.c.Isthereturnontheone-yearT-billriskfree?SupposeMSIwantstoconstructaportfolioofstocksthathasanexpectedreturnequaltotherisk- freerate.Issuchaportfoliopossible?Issuchaportfoliolikely?Supposethatyouchoosetoholdasinglestockinvestmentinisolation.Would youbecompensated foralloftheriskthatyouassume?Explain.7. Inyouropinion,whatarethreekeylearningpointsfromthiscase?

 

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