Intermediate Financial Management
14th Edition
ISBN: 9780357516782
Author: Brigham, Eugene F., Daves, Phillip R.
Publisher: Cengage Learning
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Chapter 3, Problem 5MC
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:
Construct a plausible graph that shows risk (as measured by portfolio standard deviation) on the x-axis and expected
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A portfolio manager summarizes the input from the macro and micro forecasters in the following table:
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a. Calculate expected excess returns, alpha values, and residual variances for these stocks. (Negative values should be indicated by a minus sign. Do not round intermediate calculations. Round "Alpha values" to 1 decimal place.)
b. What should be the exact makeup of the complete portfolio (including the risk-free asset) for an investor with a coefficient of risk aversion of 3.2? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
final positions
bills
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Richard Roll, in an article on using the capital asset pricing model (CAPM) to evaluate portfolio performance, indicated that it may not be possible to evaluate portfolio management ability if there is an error in the benchmark used.a. In evaluating portfolio performance, describe the general procedure, with emphasis on the benchmark employed.b. Explain what Roll meant by benchmark error and identify the specific problem with this benchmark.c. Draw a graph that shows how a portfolio that has been judged as superior relative to a “measured” security market line (SML) can be inferior relative to the “true” SML.d. Assume that you are informed that a given portfolio manager has been evaluated as superior when compared to the Dow Jones Industrial Average, the S&P 500, and the NYSE Composite Index. Explain whether this consensus would make you feel more comfortable regarding the portfolio manager’s true ability.e. Although conceding the possible problem with benchmark errors as set forth…
Which of the following choices best completes the following statement? Explain. An investor with a higher degree of risk aversion, compared to one with a lower degree, will most prefer investment portfoliosa. with higher risk premiums.b. that are riskier (with higher standard deviations).c. with lower Sharpe ratios.d. with higher Sharpe ratios.
Chapter 3 Solutions
Intermediate Financial Management
Ch. 3 - Security A has an expected rate of return of 6%, a...Ch. 3 - The standard deviation of stock returns for Stock...Ch. 3 - APT
An analyst has modeled the stock of Crisp...Ch. 3 - Two-Asset Portfolio
Stock A has an expected return...Ch. 3 - Prob. 4PCh. 3 - You have been hired at the investment firm of...Ch. 3 - You have been hired at the investment firm of...Ch. 3 - You have been hired at the investment firm of...Ch. 3 - You have been hired at the investment firm of...Ch. 3 - You have been hired at the investment firm of...
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- 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_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 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: Plot the attainable portfolios for a correlation of 0.35. Now plot the attainable portfolios for correlations of +1.0 and −1.0.arrow_forward
- 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: Suppose a risk-free asset has an expected return of 5%. By definition, its standard deviation is zero, and its correlation with any other asset is also zero. Using only Asset A and the risk-free asset, plot the attainable portfolios.arrow_forwardWhat is the answer to this question? For this question I have seen 2 answers. So im not sure whats right. Answer 1: The most relevant figure is (a) that reflects the risk-return characteristics of stock A and stock B. an effective frontier is called relationship between risk (standard deviation) and expected return. The shape of risk-return features is curved because for each incremental risk incurred there are raising marginal returns. Therefore, for each unit of risk, the standard deviation applied to the portfolio provides an extremely low amount of return. Also we can see that the SD of stock B is higher than that of A. Figure b) is incorrect because the returns don’t rise in proportion to the risk assumed. Figure c) is incorrect since both stocks stock A and stock B are risky, and thus a finite return cannot occur at standard deviation = 0 Answer 2 Answer - Graph B Correlation = Covariance / (Standard deviation of A x Standard deviation of B) Correlation = 0.0014 / (0.032 x 0.044)…arrow_forwardWhich of the following statements concerning the Efficient Market Hypothesis is correct? Select one: a. Stock market prices are based on speculation not on underlying information b. New information that confirms investor expectations should change stock prices c. Stock prices should slowly respond when unexpected information becomes available d. Careful research can help investors earn abnormal profits e. Your return on investment should reflect the riskiness of your portfolioarrow_forward
- 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?arrow_forwardYou are a portfolio manager. John Smith, one of your clients, by providing you the following formation requested you to calculate standard deviation of Shah Corporation stock and High Fly Corporation. Based on the given information, what is the standard deviation of the returns on i) Shah Corporation and ii) High Fly Corporation? Which stock has higher standard deviation? Why? Please provide your reasoning. Please show all the calculations by which you came up with the final answer.arrow_forwardwhat are the challenges faced by an investment advisor in managing investor expectations in volatile market conditions? Additionally, can you validate the statement: According to Harry Markowitz, the risk of well-diversified portfolio is less than the risk of the candidate used in the portfolio.arrow_forward
- When working with the CAPM, which of the following factors can be determined with the most precision? a. The most appropriate risk-free rate, rRF. b. The market risk premium (RPM). c. The beta coefficient, bi, of a relatively safe stock. d. The expected rate of return on the market, rM. e. The beta coefficient of "the market," which is the same as the beta of an average stock.arrow_forwardA portfolio consisting of two assets has a correlation coefficient of 0.7. Another two-asset portfolio has a correlation coefficient of -0.6. In the absence of any other information, which portfolio should you invest in, if your main goal is to eliminate risk? Justify your reasoning. How does your answer change if your main goal is to take a certain market view and hence make a side bet? Explain more generally the advantages and disadvantages of using correlation in the decision-making process within a portfolio management context. Make sure to mention what correlation is, and what is not, as a metric tool for investment decisions.arrow_forwardan investment market, understanding the concept of undervalued and overvalued stocks is very important. Hence, a prudent investor must have good knowledge about Beta, Market Rate of Return and Risk Free Rate of Return. Give a graphical example to present the positioning of: Systematic riskarrow_forward
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