Financial Management: Theory & Practice
16th Edition
ISBN: 9781337909730
Author: Brigham
Publisher: Cengage
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Chapter 25, Problem 1MC
Summary Introduction
Determine: Expected return and standard deviation of the portfolio invested.
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Sharon Smith, the financial manager for Barnett Corporation, wishes to select one of three prospective investments: X, Y, and Z. Assume that the measure of risk Sharon cares about is an asset's standard deviation. The expected returns and standard deviations of the investments are as follows:
Investment
Expected
return
Standard
deviation
X
17%
7%
Y
17%
8%
Z
17%
9%
a. If Sharon were risk neutral, which investment would she select? Explain why.
b. If she were risk averse, which investment would she select? Why?
c. If she were risk seeking, which investments would she select? Why?
d. Suppose a fourth investment, W, is available. It offers an expected return of 18%,and it has a standard deviation of 9%. If Sharon is risk averse, can you say which investment she will choose? Why or why not? Are there any investments that you are certain she will not choose?
You are an investment analyst at an asset management firm. Your colleague, the in-house economist,
has analyzed all the risky securities in your economy - A, B and C. He provides you with the following
statistics:
Securities
Expected Returns
Standard Deviation 0.35 0.25 0.18
A B C
0.15 0.10 0.075 0.03
Risk-Free
The Correlation between A and B is 0.2, between B and C is 0.5, and between A and C is 0.3. The
prevailing risk-free rate is 3%.
What is the Sharpe ratio of the market portfolio in this economy?
You are an investment analyst at an asset management firm. Your colleague, the in-house economist, has analyzed all the
risky securities in your economy - A, B and C. He provides you with the following statistics:
A B C
Risk-Free
Securities
Expected Returns
Standard Deviation 0.25 0.20 0.12
0.12 0.11 0.08 0.01
The Correlation between A and B is 0.25, between B and C is 0.75, and between A and C is 0.5.
What is the slope of the capital market line in this economy?
Group of answer choices
0.27
0.58
0.62
0.66
052
Chapter 25 Solutions
Financial Management: Theory & Practice
Ch. 25 - Define the following terms, using graphs or...Ch. 25 - Prob. 2QCh. 25 - The standard deviation of stock returns for Stock...Ch. 25 - Prob. 2PCh. 25 - Stock A has an expected return of 12% and a...Ch. 25 - Prob. 4PCh. 25 - Prob. 7SPCh. 25 - Prob. 1MCCh. 25 - Prob. 2MCCh. 25 - Prob. 3MC
Ch. 25 - You have been hired at the investment firm of...Ch. 25 - You have been hired at the investment firm of...Ch. 25 - Prob. 6MCCh. 25 - You have been hired at the investment firm of...Ch. 25 - You have been hired at the investment firm of...Ch. 25 - Prob. 9MCCh. 25 - You have been hired at the investment firm of...Ch. 25 - Prob. 11MC
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- You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: What are two potential tests that can be conducted to verify the CAPM? What are the results of such tests? What is Roll’s critique of CAPM tests?arrow_forwardYou have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: Write out the equation for the Capital Market Line (CML), and draw it on the graph. Interpret the plotted CML. Now add a set of indifference curves and illustrate how an investor’s optimal portfolio is some combination of the risky portfolio and the risk-free asset. What is the composition of the risky portfolio?arrow_forwardYou have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: What is the Capital Asset Pricing Model (CAPM)? What are the assumptions that underlie the model? What is the Security Market Line (SML)?arrow_forward
- You have been hired at the investment firm of Bowers Noon. One of its clients doesnt understand the value of diversification or why stocks with the biggest standard deviations dont always have the highest expected returns. Your assignment is to address the clients concerns by showing the client how to answer the following questions: d. Construct a plausible graph that shows risk (as measured by portfolio standard deviation) on the x-axis and expected rate of return on the y-axis. Now add an illustrative feasible (or attainable) set of portfolios and show what portion of the feasible set is efficient. What makes a particular portfolio efficient? Dont worry about specific values when constructing the graphmerely illustrate how things look with reasonable data.arrow_forwardJohn Davidson is an investment adviser at Leeds Asset Management plc. He is asked by a client to evaluate various investment opportunities currently available and he has calculated expected returns and standard deviations for five different well-diversified portfolios of risky assets: Portfolio Expected return Standard deviation Q 7.8% 10.5% R 10.0% 14.0% S 4.6% 5.0% T 11.7% 18.5% U 6.2% 7.5% (a) For each portfolio, calculate the risk premium per unit of risk (Sharpe ratio) that you expect to receive. Assume that the risk-free rate is 3.0%. (b) Using answers from a, which of these five portfolios is most likely to be the market portfolio and explain why. (200 words maximum) (c) If you are only willing to make an investment with a standard deviation of 7.0%, is it possible for you to earn a return of 7.0%? (d) What is the minimum level of risk that would be necessary for an investment to earn 7.0%? What is the composition of the…arrow_forwardJohn Davidson is an investment adviser at Leeds Asset Management plc. He is asked by a client to evaluate various investment opportunities currently available and he has calculated expected returns and standard deviations for five different well-diversified portfolios of risky assets: Portfolio Expected return Standard deviation Q 7.8% 10.5% R 10.0% 14.0% S 4.6% 5.0% T 11.7% 18.5% U 6.2% 7.5% (a) For each portfolio, calculate the risk premium per unit of risk (Sharpe ratio) that you expect to receive. Assume that the risk-free rate is 3.0%. (b) Using answers from a, which of these five portfolios is most likely to be the market portfolio and explain why. (200 words maximum)arrow_forward
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