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6. Returns on an investment are uncertain. You estimate the likelihood of alternative returns based on the estimated probabilities of possible outcomes:

Outcome Return Estimated Probability of Outcome
1 3% .05
2 7% .25
3 10% .40
4 13% .25
5 17% .05

a. Calculate the expected return.
b. Calculate the standard deviation of the return

7. Dublin Plastics Inc.’s stock is selling for $17.60. Your research suggests it will pay dividends of $2.00 next year and $2.80 the following year, after which its stock price will have peaked at $21.00. You require a return of 20% on similar investment risk. Should you buy now and sell when the price reaches $21.00?

8. A four-stock portfolio is made up as follows:

Stock Current
Value Beta
A $15,300 .5
B $28,700 .9
C $19,600 1.2
D $10,400 1.7

a. Calculate the portfolio’s beta
b. How relatively risky is this portfolio? Could the portfolio have more risk? Could the portfolio have less risk? Explain.

9. Given the following information, calculate the required return on MNO Corporation’s common stock:
? MNO Corp.’s Common Stock Beta (ß) = 0.9
? Risk-free rate = 5%
? Required return on the overall market = 11%

Suppose your tax bracket is 20%.

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1. Suppose your tax bracket is 20%. Would you prefer to earn a 8% taxable return or a 6% tax-free return? What is the equivalent taxable yield of the 6% tax-free return?

2. Suppose that HP is currently selling at $25 per share. You buy 500 shares using $7,500 of your own money and borrowing the remainder of the purchase price from your broker. The rate on the margin loan is 6%. If the maintenance margin is 25%, how low can HP’s price fall before you get a margin call?

a. What is the expected return of a stock given the following information:
State of Probability Return
Economy

Good .1 15%
Normal .6 13
Poor .3 7

b. What is the standard deviation of returns?

3. A stock has a beta of 1.5, the risk free rate is 6% and the expected market return is 12%. What is the required rate of return using the CAPM model? If the expected return for the stock is 14.5%, would you recommend purchasing the shares now? Explain your answer in detail.

1.Compare the following risk preferences: (a) risk-averse, (b) risk-indifferent, and (c) risk-seeking. Which is most common among financial managers?

2.Explain how the range is used in sensitivity analysis.

3. Explain the meaning of each variable in the capital asset pricing model (CAPM) equation. What is the security market line (SML)?

1. Why is it important to focus on total returns when measuring an investment’s performance?

7. Stock A has a beta of 1.5, and stock B has a beta of 1.0. Determine whether each of the statements below is true or false.

a. Stock A must have a higher standard deviation than Stock B.
b. Stock A has a higher expected return than Stock B.
c. The expected return on Stock A is 50 percent higher than the expected return on B.

I need help getting started with this assignment. The two companies I am using are Daimler Chrysler and Citigroup.

A. Calculate your portfolio’s performance using the Jensen index.
B. Describe the importance of these measures and interpret how your portfolio performed versus the market index.
C. Based on these indices discuss how you would revise your portfolio.

Please describe, using at least 150 words for each company. Please show any calculations using excel.

Is the following statement True, False, or Ambiguous? Provide a short justification for your
answer (you are evaluated on the justification).

“In the CAPM model, since investors are compensated for holding risk, two securities with the same standard deviation should have the same expected return.”

Imagine you are Bill.

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Questions:
1. Imagine you are Bill. Compute the expected rate of return and standard deviation of individual stocks and explain to Mary the relationship between risk and return.
2. Mary has no idea what beta means and how it is related to the required return of the stocks. Explain how you would help her understand these concepts.

Case:

Risk and Return
When Mary Owens’ husband, Ralph, passed away about three months ago he left behind a small
fortune, which he had accumulated by living a very thrifty life and by investing in common stocks.
Ralph had worked as an engineer for a surgical instruments manufacturer for over 30 years and had
taken full advantage of the company’s voluntary retirement savings plan. However, instead of buying
a diversified set of investments he had invested his money into a few high growth companies. Over
time his investment portfolio had grown to about $900,000 being primarily comprised of the stocks of
3 companies. He was very fortunate that his selections turned out to be good ones and after numerous
stock-splits the prices of the three companies had appreciated significantly over time.

Mary, on the other hand, was a very conservative and cautious person. She had devoted her life to
being a stay-home mom and had raised their two kids into fine adults, each of whom had a fairly
successful career. Jim, 28, had followed in Ralph’s footsteps. In addition to being gainfully employed
as an engineer, he was pursuing an MBA at a prestigious business school. Annette, 26, was
completing her residency at a major metropolitan hospital. Although Mary and Ralph had enjoyed a
wonderful married life, it was Ralph who managed almost all the financial affairs of their family.
Mary, like many spouses of their generation, preferred to focus on other family matters.

It was only after Ralph’s passing on that Mary realized how unprepared she was for the complex
decisions that have to be made when managing one’s wealth. Upon the advice of her close friend,
Agnes. Mary decided to call the broker’s office and request that her account be turned over to Bill
May, the firm’s senior financial advisor. Agnes, a widow herself, had been very happy with Bill’s
advice and professionalism. He had helped her rebalance and re-allocate her portfolio with the result
that her portfolio’s value had steadily increased over the years without much volatility.

At their first meeting, Bill examined the Owens’ portfolio and was shocked at how narrowly
focused its composition had been. In fact, just during the past year – due to the significant drop in the
technology sector – the portfolio had lost almost 30% of its value. “Ralph, certainly liked to flirt with
risk,” said Bill. “The first thing we are going to have to do is diversify your portfolio and lower its
beta. As it stands you could make a lot of money if the technology sector takes off, but the reverse
scenario could be devastating. I am sure you will agree with me that given your status in life you do
not need to bear this much of risk.” Mary shrugged her shoulders and looked blankly at Bill.

“Diversify….Beta…what are you talking about? These terms are new to me and so confusing. You
are right, Bill, I don’t need the high risk but can you explain to me how the risk level of my portfolio
can be lowered?” Bill realized right away that Mary needed a primer on the risk-return tradeoff and on
portfolio management. Accordingly, he scheduled another appointment for later that week and
prepared Exhibit 1 to demonstrate the various nuances of risk, expected return, and portfolio
management.

Exhibit 1
Expected Rate of Return
Scenario Probability Treasury Bill Index Fund
Utility
Company
High-Tech
Company
Counter-
Cyclical
Company
Recession 20% 4% -2% 6% -5% 20%
Near Recession 20% 4% 5% 7% 2% 16%
Normal 30% 4% 10% 9% 15% 12%
Near Boom 10% 4% 15% 11% 25% -9%
Boom 20% 4% 25% 14% 45% -20%
Beta 0 1 0.3 1.86 -1.54

Questions:
1. Imagine you are Bill. Compute the expected rate of return and standard deviation of individual stocks and explain to Mary the relationship between risk and return.
2. Mary has no idea what beta means and how it is related to the required return of the stocks. Explain how you would help her understand these concepts.