Part 2 tkm0844 11e Im ch08

SolutionstoEndofChapterProblemsChapter8215
Chapter8
RiskandReturn:CapitalMarketTheory
81.
TofindtheexpectedreturnfromJamesFromholtzsinvestmentopportunity,wewilluseequation73:
n
E (rportfolio ) (probability i ) * E (return i ),

i 1
whereiindexesthevariousstatesofnaturethatarepossible.Wecanpicturethestatesofnaturefor
Jamessopportunityas:
Despitethesymmetricalappearanceofthegraph,theoutcomesarenotsymmetrical:Thereare
manymoreoutcomesthatarepositivethannegative.Onlythe100%return(probability5%)is
negative;95%oftheweightofthedistributionispositive.Wecouldstillhaveanegativeexpected
returnifthemagnitudeofthenegativereturnwerelargeenoughtooverwhelmtheotherpossible
outcomes.However,thatwonthappenhere,sincethe+100%return,whichalsohasa5%chance
ofoccurring,balancesouronenegativeoutcome.
A. Applyingequation73toourprobabilitydistributionofreturns,wehave:
E(r)(0.05)(100%)(0.45)(35%)(0.45)(5%)(0.05)(100%)18%.
2011PearsonEducation,Inc.PublishingasPrenticeHall
216Titman/Keown/MartinFinancialManagement,EleventhEdition
Wecanseethesecalculationsinthespreadsheetbelow.Notethattheprobabilitiesmustsum
to1(100%).
B. Theexpectedreturnforthisinvestmentispositive,asitwillbeforallinvestmentsonanexante
basispeoplewouldntinvestiftheyexpectedtolosemoney!(Thisiswhatdistinguishes
investingfromgambling.)However,justbecausetheexpectedreturnispositivedoesnotmean
thatIwouldnecessarilyinvest.Theexpectedreturnmustbesufficienttocompensatemeforthe
riskthatIbear.Knowingthatthereisapossibilityofanegativeoutcomeisnotsufficientasa
measureofrisk.Therefore,IcantsaywhetherornotIdinvestinthisopportunityIdneed
moreinformation.PartofwhatIdneedtoknowwewillfindoutinProblem82(butagain,that
wontbeenough!).
82.
TofindthestandarddeviationoftheprobabilitydistributiongiveninProblem81,wewilluse
equation75:
(r E(r ))
i 1
* probi ,
whereIindexesthevariousstatesofnature.ForJamesFromholtzsopportunity,wehave:
(100% 18%)2 * (0.05) (35% 18%)2 * (0.45)

(5% 18%)2 * (0.45) (100% 18%)2 * (0.05)
35.19%
Wecanseethecalculationsmoreclearlyfromthespreadsheetbelow:
(Inequation75,thevarianceisthequantityundertheradicalsign;thestandarddeviationisthen
thesquarerootofthevariance: 2 .)
83.
MaryGuilottisconsideringcreatinganequallyweightedportfolioofstocksAandB.(Equally
weightedmeansthateachassethasthesameweight,equalto 1n , wherenisthenumberofassets.
Sincewehavetwoassetshere,anequallyweightedportfolioputs50%ofthetotalinvestmentinto
eachstock.)Tofindtheexpectedreturnofthisportfolio,weuseequation81:
n
E (rportifolio ) (weight i ) E (ri ),

i 1
whereiindexestheassetsincludedintheportfolio.
A. SinceMaryisconsideringtwoassets,whoseexpectedreturnsare15%and10%,wehave:
E(rportfolio)(0.50)(15%)(0.50)(10%)12.5%.
Thesecalculationsaredetailedinthespreadsheetbelow:
Theexpectedreturnisexactlybetweenthetwoassetsreturns,sincetheportfolioisequally
weighted.Notethatwedidnotusethecorrelationcoefficienthere:Theexpectedreturnona
portfolioisnotaffectedbytheassetscorrelation.Wewillthereforenotneedtochangethe
expectedreturnasweexplorevariouscorrelationvaluesbelow.
B. Tofindtheportfoliosstandarddeviation,wefirstfindthevarianceas:
2
portfolio
(weight A )2 ( A2 ) (weight B )2 ( B2 )
2 (weight A ) (weight B ) A B AB ;
2
thenwefindthestandarddeviationasthesquarerootofthisvariance:portfolio portfolio
.
(Thisiswhatisdoneinonestepinthetextsequation83.)
Thus,forMarysportfolio,wehave:
2
portfolio
(0.50)2 (0.12)2 (0.50)2 (0.06)2 2 (0.50) (0.12) (0.06) (0.4)
0.0059,
and:
portfolio .0059 0.0771 7.71%.
C.E.
Thisresultwillchangeifwechangethecorrelationcoefficient.Theloweris ,thelower
willbethestandarddeviationoftheportfolio.Thisisthebenefitofdiversification.We
canseethisinthetableandchartbelow:
Whenthecorrelationcoefficientis1(thatis,whenassetsAandBareperfectlynegatively
correlated),wehavereducedtheportfoliosstandarddeviationtoitslowestpossiblevaluefor
thisweightingscheme:allthewaydownto3%.At0(thatis,whentheassetsareindependent),
thestandarddeviationat6.71%ishigherthanintheperfectnegativecorrelationcase,but
stilllowerthantheoriginalsituation.The1case,perfectpositivecorrelation,istheworst
casescenario.Here,theportfoliosstandarddeviationissimplyaweightedaverageofthe
assetsstandarddeviations,sothatthereisabsolutelynobenefitfromdiversification.However,
itishighlyunlikelythatanytwostocksreturnswillbeperfectlypositivelycorrelated(letssay
impossible),soingeneraltherewillbebenefittodiversification.
84.
A. Tofindtheexpectedreturnandstandarddeviationofaportfoliowith10%inAand90%inB
(usingthetwostocksfromProblem83),weproceedasbefore:
E(rportfolio)(weightinA)(E(r)ofA)(weightinB)(E(r)ofB)
(0.10)(15%)(0.90)(10%)10.5%.
Notethatthisexpectedreturnislowerthanthe12.5%wefoundinProblem83fortheequally
weightedportfolio;thisisbecausewehavetakenalargerweighthereintheloweryielding
stock,B.MoreweightinBmeanslowerportfolioexpectedreturns.
Fortheportfoliosvarianceandstandarddeviationwehave:
2
portfolio
(weight A )2 ( A2 ) (weight B )2 ( B2 ) 2 (weight A ) (weight B ) A B AB ,
(0.10)2 (0.12)2 (0.90)2 (0.06)2 2 (0.90) (0.10) (0.12) (0.06) (0.40)

0.0036
2
portfolio portfolio
0.0036 0.0598 5.98%.
Thecorrelationcoefficientweusedherewas0.40,whichwasthesamevalueweusedearlierin
Problem83.Theportfoliostandarddeviationissmallerinthiscase,however,becausewehave
putmoreweightinthelowerriskasset,B,thesecondterminthevarianceequationaboveis
now(0.90)2(0.06)2insteadof(0.50)2(0.06)2.However,notethatwehavedonemorethan
simplyoverweightthelowerriskasset;theeffecthereisnotthesameaswhatwefoundforthe
expectedreturn.Here,wehaveactuallyreducedtheportfoliostandarddeviationbelowthe
standarddeviationforthelowerriskasset!Thisistheeffectofdiversificationaneffectthatis
missingintheexpectedreturncalculation.Notethatthisdiversificationwillbeevenmore
pronouncedwhenweuseacorrelationcoefficientof0.40;wewillthenbesubtractingthe
variancesthirdtermfromthetotalinsteadofaddingit.
B.D.
Theresultsfortherestofthescenariosoutlinedintheproblem,plusafewothers,are
showninthetablebelow.Inthechart,notethefollowing:
Expectedreturnisnotafunctionofthecorrelationcoefficient,sowedonotfindvaluesfor
both0.4and0.4.
Thevarianceandstandarddeviationsaresmallerwhen 0.4thanwhen0.4,except
whentheweightineitherassetis0.(Inthosecases,theportfoliostandarddeviationequals
thestandarddeviationoftheincludedasset.)
Thesevaluesaregraphedbelow:
Inthegraph,notethat:
Thevaluesonthefarleft,wheretheweightinAis0,areforassetB.Itisthelowerriskand
lowerreturnasset.
ThevaluesatthefarrightareforassetA.Itisthehigherriskandhigheryieldasset.
Aswemovetotheright,theweightinAincreases.Thisdragstheportfolioexpectedreturn
up,andtheriskup.However,whiletheincreaseinE(r)islinear(becausetheexpected
returnofaportfolioisaweightedaverageoftheexpectedreturnsoftheassetsinit),the
relationshipforstandarddeviationisnotlinear.Unless1,thestandarddeviationofa
portfolioisnotaweightedaverageofthestandarddeviationsoftheassetsinit.The
diversificationpotentialforassetsthatarentperfectlypositivelycorrelatedmeansthatthe
portfoliocanbecomelessriskyasweaddmoreoftheriskierasset!Wecanseethisquite
clearlyusingthegreencurvewheretheassetsarenegativelycorrelated,i.e.,rho0.4:As
weincreasetheweightinA,theportfoliostandarddeviationdecreasesuntilwegetslightly
aboveanequalweightinA.
Heresanotherwaytovisualizetheserelationships.NowwereplottingportfolioE(r)against
portfoliostandarddeviation.Investorspreferportfoliosthatarehigher(increasedE(r))andmore
totheleft(lower).ThecurvesarecreatedbycombiningAandBindifferentproportions.
Notehowmuchbettertheportfoliosbehavewhenweassumethattheassetsarenegatively
correlatedtheopportunitieswecancreateliemuchfurthertotheleft.Again,thisistheeffect
ofdiversification.Lowercorrelationmeansthereismorediversificationpotential,andwesee
thisastheportfolioswecreatewith0.40lietotheleftofthosewecreatewith0.40.
85.
A. WecanfindtheexpectedreturnofPennyFrancissportfoliousingequation81:
E(rportfolio)(weightinTbills)(E(r)ofTbills)(weightinF)(E(r)ofF)
(weightinHOG)(E(r)ofHOG).
Theonlyquestioniswhattheproperweightsare.Theportfolioweightforanassetisthe
proportionoftotalportfoliodollarsallocatedtothatasset.ThusPennyhas$40,000inTbills,
outofatotalportfoliovalueof($40,000$30,000$30,000)$100,000,soherweightin
$40,000
Tbillsis ( $100,000 ) 4%. Theothertwoassetsweightsareeach30%.Thuswehave:
E(rportfolio)=(0.40)(4.5%)(0.30)(8.0%)(0.30)(12.0%)7.8%.
Notethatthisweightedaverageisbetweenthehighestvaluewereaveraging,12.0%,andthe
lowestvaluewereaveraging,4.5%.
B. IfPennyweretochangeherportfoliocompositionto50%Fand50%HOG($50,000ineach),
thenherexpectedreturnwouldriseto10%(halfwaybetweentheexpectedreturnsofFandHOG):
C. Whywouldntshewanttodothis?Shemightnotwanttoincreaseherportfoliosrisk.The
increaseinexpectedreturnthatshewouldgeneratebyreducingherallocationtoTbillscomes
atacost.FandHOGhavehigherstandarddeviationsthandoTbills.
Howdoweknowabouttherelativerisk,ifwerenotgiventhisinformation?Stocksareriskier
thanbonds,andTbillsarethelowestriskdebtassetsintheworld.Ifstockswerenot,on
average,muchmorevolatilethandebt,theneveryonewouldwanttoholdstocksexclusively.
Whowouldntwantanassetwithhigherexpectedreturnandlowerrisk?Unfortunatelyfor
investors,itdoesntworkthatway.Thereisariskreturntradeoff,andPennywillconfrontit
headonifshemoveshermoneyoutofhersafeTbills.
86.
A. WecanfindtheexpectedreturnofBarrySwiftersportfoliousingequation81:
E(rportfolio)=(weightinTbills)(E(r)ofTbills)(weightinS&P)(E(r)ofS&P)
(weightinEMF)*(E(r)ofEMF).
Theonlyquestioniswhattheproperweightsare.Theportfolioweightforanassetisthe
proportionoftotalportfoliodollarsallocatedtothatasset.ThusBarryhas$75,000inTbills,out
$75,000
ofatotalportfoliovalueof$750,000,sohisweightinTbillsis ( $750,000 ) 10%.Wecanfind
$450,000
theothertwoassetsweightsthesameway:FortheS&P500fund,its ( $750,000 ) 60%,andfor
$225,000
theemergingmarketsfund,its ( $750,000 ) 30%.Thusforhisportfoliowehave:
E(rportfolio)=(0.10)(4.5%)(0.60)(8.0%)(0.30)(12.0%)8.85%.
Notethatthisweightedaverageisbetweenthehighestvaluewereaveraging,12.0%,andthe
lowestvaluewereaveraging,4.5%.
Wecanseethedetailsofthesecalculationsinthespreadsheetbelow:
B. IfBarryweretoreducetheriskofhisportfoliobymovingallofhisemergingmarketsmoney
intoTbills,hewouldlowerhisexpectedreturn,asshownbelow:
Nowhisexpectedreturninonly6.6%,aweightedaverageoftherateontheS&P500fund,8%,
andthatonTbills,4.5%.(Hisportfolioreturnisnotexactlybetweenthesetwoassetreturns,of
course,becausehehasmoreofhismoneyintheS&P500fund.Thushisportfoliosexpected
returnisclosertothatoftheS&PthantothatofhisTbills.)
87.
TocomparethetwoportfoliosthatKellyB.Stilesisconsidering,wewillcomputetheirexpected
returnsandstandarddeviations.WewillbeusingtheequationsfromChapter7,sincethedatawe
aregivenarefortheportfoliosasindividualassets.Thuswewilluseequation73:
n
E (rportfolio ) (probability i ) * E(return i ),

i 1
andequation75:
(r E(r ))
i 1
* probi .
Forexample,forportfolioA,wehave:
E(r)(0.20)(2%)(0.50)(19%)(0.30)(25%)16.6%,
and:
(2% 16.6%)2 (0.20) (19% 16.6%)2 (0.50) (25% 16.6%)2 (0.30)

9.66%.
Thesecalculations,andthoseforportfolioB,areshowninthespreadsheetonthenextpage.
Whichinvestmentisbetter?Asshowninthegraphabove,neitherisbetter,sinceneither
dominates.Thatis,neitherassetispreferredbothonexpectedreturn(higher)andrisk(lower).
MovingfromBtoAmeansincreasingexpectedreturn(good)butalsoincreasingrisk(bad).Thus
areasonableinvestorcouldchooseeither.Whichisbetterforyoudependsonyourrisktolerance.
88.
Wearegivenbetavaluesfromtwosourcesfortwotypesoffirms,computerfirmsandutilities.We
aretousethebetaestimatestofindthechangesinthestockvaluefora10%riseanda10%fallin
themarket.
Afirmsbetamagnifies(ormutes)theeffectofthemarketschangesonthestock.Thatis:
changeinstockvalue(stockbeta)(changeinmarketsvalue).
WecanseethisfromtheCAPM.Afirmsstocksexpectedreturncanbefoundas:
E(ri)rriskfree i* [E(rmarket)rriskfree].
Now,ifthemarketsexpectedreturnchanges,thestocksexpectedreturnwill,too:
E(ri)new=rriskfree+ i* [E(rmarket)newrriskfree].
Thechangeinthefirmsexpectedreturnisthen:
E(ri)newE(ri){rriskfree i* [E(rmarket)newrriskfree]}{rriskfree i* [E(rmarket)rriskfree]}
i* [E(rmarket)newE(rmarket)].
Thuswecansimplysubstitute10%and10%forthechangeinmarketexpectedreturntofindthe
changesinourstocksexpectedreturns.
(Thisproblemiswrittenusingrealizedstockreturns,notexpectations.ThatsOK.Usingthe
CAPMasthebasisforamodelexplainingtherealizedreturntoastockleadstothesameresult:
beta*(%changeinmarket)=%changeinstock.)
Theresultsforourstocksarebelow,forboththeYahoo!FinancebetasandtheMicrosoftMoney
Centralbetas.
Notethefollowing:
Thestockschangesaresymmetrical:Themagnitudeoftheirchangesisthesamewhetherthe
marketrisesby10%orfallsby10%;onlythedirectionofmovementisdifferent.
Thecomputerstocksareaggressive:Theirbetasaregreaterthan1.Thustheirstocksmovemore
thanthemarket(morethan10%eitherway).However,theutilitiesaredefensive(betas<1);
theirstocksmoveinthesamedirectionasthemarket,butbylessthan10%inallcases.
ThereisnoconsistentrelationshipbetweentherelativevaluesfortheMicrosoftandYahoo!beta
estimates:SometimestheYahoo!valuesarehigherinmagnitude(e.g.,AAPL);sometimesthey
aresmaller(e.g.,DUK).However,bothsourcesalwaysagreeaboutthedefensivenessor
aggressivenessofthestockrelativetothemarket.Thereisalsooftenagreementwithinagroup
aboutthemostextremestocks(e.g.,bothhaveAAPLastheriskiestofthecomputerstocks,and
DUKastheleastriskyoftheutilities),butthisisnotalwaystrue.
Ourresultsaregraphedbelow.Foreachstock,weshowfourbars:twoeachfortheMicrosoftbeta
estimates(marketupandmarketdown)andfortheYahoo!estimates.Notethatthevariabilityin
thefirstthreestocksthecomputerstocksismuchgreaterthanthatfortheutilities.
89.
WearetousethevisualmethodtoestimateB&ATruckingsbeta,giventherelationshipdepicted
below:
Thebetaestimatewillbetheslopeoftheredlineinthegraphthelineofbestfit.Sincetheslope
ofalinecanbefoundwithonlytwopoints,wewillusethetwopointsthatactuallylieontheline:
(25%,20%)andtheorigin.Thus:
Thespreadsheetaboveshowsthattheslopeis0.80.Thatis:
slope
rise 0% (20%)
0.80.
run [0% ( 25%)]
(Itdoesntmatterwhichpointsxandyvaluesweputfirstwhenfindingtheriseandrun
differences,aslongasweareconsistent.)Thepositivevalueimpliesthatthestocksreturnmoves
inthesamedirectionasthemarkets,whichitdoes:Wecanseethisfromthepositiveslopeofthe
redlineinthegraph.However,sincetheslopethatis,thebetaislessthan1,thestockis
defensive,risingandfallingbyasmallerpercentagethanthemarket.ThusB&ATruckingsstock
islessriskythanthemarket.
810. A. WearegivenvaluesforbothSugitaCorporationsandthemarketshistoricalreturns.Theseare
showninthetablebelowincolumnsBandE,respectively.
Tofindtheaverages,wewillsimplyaddthereturnsforeachasset,thendividebythenumberof
returns.Forexample,forSugita,wehave:
6
averagereturn
return
i 1
whereiindexesthe6monthlyreturns,andnisthenumberofreturns(son=6).Thus:
averagereturn Sugita
1.8% 0.5% 2% 2% 5% 5%
1.88%.
6
Thisisshowninthetableabove,asthearithmeticaverage.Rightbelowthatis
AVERAGE1.88%,inagraybox.ThegrayboxesdenoteExcelfunctions.Thus,use
AVERAGE(values)tofindtheaverageusingExcel.
Tofindthevarianceofthereturnseries,weusethefollowingequation:
6
variance
(return
i 1
mean)2
(n 1)
whereusingthe(n1)inthedenominatorisacorrectionforstatisticalbias.(Weuse[n1]
withsampledata,aswehavehere.Wedividebynifwehavepopulationdata.)ThusforSugita,
wehave:
(1.8% 1.88%)2 (0.5% 1.88%)2
varianceSugita0.0008
(2% 1.88%)2 (2% 1.88%)2

(5% 1.88%)2 (5% 1.88%)2
(6 1)
Thestandarddeviationisthenthesquarerootofthisvariance,or2.84%.
(NotethatthisisthesameresultthatyougetfromExcelsSTDEVfunction.Thisisthesample
value.Ifyouwantthepopulationvalue,useSTDEVP.ForSugita,thispopulationvalueis
2.5887%;forthemarket,itis1.9526%.However,wewillcontinuetousethesamplevalues.)
IfweweretousetheCAPMtoestimatetheexpectedreturnforSugita,wewouldfind:
E(rSugita)rriskfree Sugita [E(rmarket)rriskfree].
*
WewillestimatetheE(rmarket)asthemarketsaveragemonthlyreturn,1.25%,times12,or15%.
Thus:
E(rSugita)4%(1.18)[15%4%]16.98%.
Thisisgreaterthanthe15%expectedreturnforthemarket,sinceSugitasbetaisaggressive
(greaterthan1).
B. TheexpectedmonthlyreturnwefoundforSugitawas1.88%,or(12)(1.88%)22.6%peryear.
ThisishigherthantheestimategivenfromtheCAPM.Sugitasbetamaynowbehigherthan
1.18.(Betascanchangeovertime.However,aggressivebetastendtogetsmaller,sincebetas
tendtomovetoward1,theaverage,overtime.Ofcourse,betascanalsochangeifthefirm
changesitsoperations.PerhapsSugitaisoperatinginawaythatexposesittomoremarketrisk
thanbefore.)
811. A. WearegivenvaluesforbothZeminCorporationsandthemarketshistoricalreturns.Theseare
showninthetablebelowincolumnsBandE,respectively.
Tofindtheaverages,wewillsimplyaddthereturnsforeachasset,thendividebythenumberof
returns.Forexample,forZemin,wehave:
6
return
averagereturn
i 1
whereiindexesthe6monthlyreturns,andnisthenumberofreturns(son=6).Thus:
averagereturnZemin
6% 3% 1% 3% 5% 0%
2.00%.
6
Thusisshowninthetableabove,asthearithmeticaverage.Rightbelowthatis
AVERAGE2.00%,inagraybox.ThegrayboxesdenoteExcelfunctions.Thus,use
AVERAGE(values)tofindtheaverageusingExcel.
Tofindthevarianceofthereturnseries,weusethefollowingequation:
6
variance=
(return
i 1
mean)2
(n 1)
whereusingthe(n1)inthedenominatorisacorrectionforstatisticalbias.(Weuse[n1]
withsampledata,aswehavehere.Wedividebynifwehavepopulationdata.)ThusforZemin,
wehave:
(6% 2%)2 (3% 2%)2
varianceZemin0.0011
(1% 2%)2 ( 3% 2%)2

(5% 2%)2 (0% 2%)2
(6 1)
Thestandarddeviationisthenthesquarerootofthisvariance,or3.3466%.
(NotethatthisisthesameresultthatyougetfromExcelsSTDEVfunction.Thisisthe
samplevalue.Ifyouwantthepopulationvalue,useSTDEVP.ForZemin,thispopulation
valueis3.0551%;forthemarket,itis2.0344%.However,wewillcontinuetousethesample
values.)
IfweweretousetheCAPMtoestimatetheexpectedreturnforZemin,wewouldfind:
*
E(rZemin)rriskfree Zemin
[E(rmarket)rriskfree].
WewillestimatetheE(rmarket)asthemarketsaveragemonthlyreturn,1.17%,times12,or14%.
Thus:
E(rZemin)=4%(1.54)[14%4%]19.40%.
Thisisgreaterthanthe14%expectedreturnforthemarket,sinceZeminsbetaisaggressive
(greaterthan1).
B. TheexpectedmonthlyreturnwefoundforZeminwas2%,or(12)(2%)24%peryear.This
ishigherthantheestimategivenfromtheCAPM.Zeminsbetamaynowbehigherthan1.54.
(Betascanchangeovertime.However,aggressivebetastendtogetsmaller,sincebetastendto
movetoward1,theaverage,overtime.Ofcourse,betascanalsochangeifthefirmchangesits
operations.PerhapsZeminisoperatinginawaythatexposesittomoremarketriskthanbefore.)
812. A. InProblem81,wefoundthatJamesFromholtzhadaninvestmentopportunitywithanexpected
returnof18%.HewishestousethisresulttofindtheslopeoftheSecurityMarketLine(SML).
Healsoknowsthatrriskfree2.5%andthebetaoftheinvestmentis2.
TheequationfortheSMLis:
E(ri)
rriskfree i* [E(rmarket)rriskfree].
(intercept)
m
(slope)
Wecanseethatthisequationistheequationforaline,andsoisintheformymxb.We
arelookingfortheslopeoftheline,whichfortheSMLis[E(rmarket)rriskfree].
SubstitutingthevalueswehaveforJamessinvestment,wesee:
18%2.5%2[E(rmarket)rriskfree],
7.75%[E(rmarket)rriskfree].
Thus,theslopeoftheSMLis7.75%.Thisisthemarketriskpremium,thenumberofextra
percentagepointsthataninvestorreceives,inequilibrium,foreachunitofriskheaccepts.
B. Jamesisalsoconsideringamarketindexinvestmentwithanexpectedreturnof10%.Ifwewere
tousethesame7.75%SMLslopethatwejustfound,thiswouldimplythatthemarketsbeta
was0.97insteadof1:
10%=2.5% mkt (7.75%) mkt0.97.
*
Ifweusethemarketbetaof1,weshouldhaveanexpectedreturnof[2.5%(1)(7.75%)]
10.25%,not10%.Ortolookatthisanotherway,atthecurrent10%expectedreturn,theimplied
slopeofthemarketindexinvestmentis7.5%,not7.75%:
10%2.5%1[E(rmarket)rriskfree],
7.5%[E(rmarket)rriskfree].
C. Nomatterhowwelookatthis,themarketindexseemstobeshavingabitfromJamessreturn.
Hewoulddobetterwiththeriskierinvestmentat18%.
813. A. UsingtheCAPM,wecaneasilyfindtheexpectedreturnforIntel.AssumingthatIntelsbetais
1.2,theriskfreerateis3.5%,andthemarketsexpectedreturnis16%,wehave:
*
E(rIntel)rriskfree Intel
[E(rmarket)rriskfree]
3.5%1.2[16%3.5%]18.5%.
Thisisgreaterthanthemarketsexpectedreturn,sinceIntelsbetaismorethan1(itsaggressive).
B. ThisisIntelsexpectedreturn(itsexantereturn),butitmaynotbeitsrealized(expost)return.
Intelisariskyinvestment.Riskmeansdispersion:WecannotbecertainaboutwhatIntels
returnwillactuallybe.(Ifwecouldbesure,thenwedknowthatitsreturnwouldbe3.5%:
certaintynorisknodispersionbetaofzeroriskfreereturn.)18.5%isourbestguessor
requiredreturnbasedonitsriskprofileversusthemarket,butourrealizationcouldbe(and
probablywillbe)different.
814. A. UsingtheCAPM,wecaneasilyfindtheexpectedreturnforAcer.AssumingthatAcersbetais
1.5,theriskfreerateis4.5%,andthemarketsexpectedreturnis10%,wehave:
*
E(rAcer)rriskfree Acer
4.5%1.5[10%4.5%]12.75%.
Thisisgreaterthanthemarketsexpectedreturn,sinceAcersbetaismorethan1(its
aggressive).
B. ThisisAcersexpectedreturn(itsexantereturn),butitmaynotbeitsrealized(expost)return.
Acerisariskyinvestment.Riskmeansdispersion:WecannotbecertainaboutwhatAcers
returnwillactuallybe.(Ifwecouldbesure,thenwedknowthatitsreturnwouldbe4.5%:
certaintynorisknodispersionbetaofzeroriskfreereturn.)Ourbestguessis12.75%
orrequiredreturnbasedonitsriskprofileversusthemarket,butourrealizationcouldbe
(andprobablywillbe)different.
815. UsingtheCAPM,wecaneasilyfindtheexpectedreturnsforseveralprojectsbeingevaluatedby
JohnsonManufacturing.Forexample,thebetaforprojectAis1.50,themarketsexpectedreturnis
10%,andtheriskfreerateis4%.Thus,forprojectA,wehave:
E(rA)rriskfree A* [E(rmarket)rriskfree]
4%1.5[10%4%]13%.
Thisopportunitysexpectedreturnisgreaterthanthemarkets,sincetheopportunitysbetais
greaterthan1.
Repeatingthisprocessfortheotherthreeinvestments,wehave:
NotethatprojectsAandDhaveexpectedreturns(andbetas)greaterthanthemarket,whileBand
Chavelowerbetasandlowerexpectedreturns.
Plottingtheseresults,wefindtheSecurityMarketLine:
816. UsingtheCAPM,wecaneasilyfindtheexpectedreturnsforseveralprojectsbeingevaluatedby
BobbiManufacturing.Forexample,thebetaforprojectAis1.40,themarketsexpectedreturnis
10%,andtheriskfreerateis3.75%.ThusforprojectA,wehave:
E(rA)rriskfree A* [E(rmarket)rriskfree]
3.75%1.4[10%3.75%]12.50%.
Thisopportunitysexpectedreturnisgreaterthanthemarkets,sincetheopportunitysbetais
greaterthan1.
Repeatingthisprocessfortheotherthreeinvestments,wehave:
NotethatprojectsAandDhaveexpectedreturns(andbetas)greaterthanthemarket,whileBand
Chavelowerbetasandlowerexpectedreturns.
Plottingtheseresults,wefindtheSecurityMarketLine:
817. UsingtheCAPM,wecaneasilyfindtheexpectedreturnsforBreckenridge,Inc.Thefirmhasabeta
of0.85.Themarketsexpectedreturnis10.5%,andtheriskfreerateis3.5%.ThusBreckenridges
expectedreturnis:
E(rBreckenridge)rriskfree Breckenridge [E(rmarket)rriskfree]
*
3.5%0.85[10.5%3.5%]9.45%.
Thefirmhasanexpectedreturnslightlylessthanthatofthemarket,sinceitsbetaisslightlyless
than1.
818. UsingtheCAPM,wecaneasilyfindtheexpectedreturnsforCSB,Inc.Thefirmhasabetaof
0.765.Themarketsexpectedreturnis10.5%,andtheriskfreerateis3.5%.ThusBreckenridges
expectedreturnis:
*
E(rCSB)rriskfree CSB
3.5%0.765[10.5%3.5%]8.855%.
Thefirmhasanexpectedreturnlessthanthatofthemarket,sinceitsbetaislessthan1.
819. Wearetoldthatthemarketriskpremiumis5.3%,andthattheexpectedreturnonthemarketis
10.3%.Sincethemarketriskpremiumisdefinedasfollows:
marketriskpremium[E(rmarket)rriskfree],
wecansolvefortheriskfreerateas:
5.3%10.3%rriskfree
rriskfree5%.
Now,wecaneasilyfindtheexpectedreturnsforourthreeassetsusingtheCAPM.Forexample,for
Tasaco,wehave:
*
E(rTasaco)rriskfree Tasaco
5%0.864(5.3%)9.58%.
WecanfindLBMsandExxossusingthesameprocess,asshownbelow:
WecangraphtheseexpectedreturnstoseetheSML:
820. A. Weownaportfoliowithfivestocks.Theportfolioproportions,betas,andexpectedreturnsfor
thesefivestocksareshownincolumnsE,B,andF,respectively,inthespreadsheetonthenext
page.Wearetofindtheportfoliosexpectedreturnandbeta.
Tofindtheportfoliosexpectedreturn,wecansolvethefollowing:
5
E (rportfolio ) (weight i ) [ E (ri )] ,

i 1
whereiindexesourfivestocks.Thuswehave:
E (rportfolio ) (0.20) (16%) (0.30) (14%)
(0.15) (20%) (0.25) (12%)
(0.10) (24%)
15.8%
whichisbetweentheexpectedreturnsofthestockwiththehighestE(r),24%,andthatwiththe
lowest,12%.
B. WecouldalsohavefoundthisusingtheCAPM.However,forthatmethod,wefirstmustfind
theportfoliosbeta.Asisexpectedreturn,aportfoliosbetaissimplyaweightedaverageofits
constituentsbetas:
5
portfolio (weight i )( i )
i 1
(0.20) (1) (0.30) (0.85)

(0.15) (1.2) (0.25) (0.60) (0.10) (1.60)
0.945.
Now,wecanusetheequationfortheSML:
E(rportfolio)rriskfree portfolio [E(rmarket)rriskfree]
*
3%0.945[10.5%3%]10.0875%.
Thisisnotthesame!Itshouldbe.Itisnthere,though,becausetheexpectedreturnsweused
abovearenotconsistentwiththeCAPM,aswewillseebelow.Hadweusedconsistentexpected
returnsforourstocks(whichwewillfindbelow),wewouldhavefoundthefollowing:
E(rportfolio)(0.20)(10.5%)(0.30)(9.375%)(0.15)(12%)
(0.25)(7.5%)(0.10)(15%)
10.0875%,
asrequired.Letsseewhatwentwronghere.
Thechartbelowlaysitallout.Theexpectedreturnsthatwewouldexpect,giventheCAPM,are
incolumnD.TheactualexpectedreturnsgivenintheproblemarethoseincolumnF.Aswesee
incolumnG,thegivenvaluesareallhigherthanthosewewouldexpectfromtheCAPM.All
fiveofthesestocksareunderpriced!
C. WecanalsoseethisfromtheplotoftheCAPM.AllofthegivenvaluesplotabovetheSML.
D. Thismeansthattheyareallofferinghigherexpectedreturnsthantheyshouldbe,giventheir
systematicrisks.Thus,theyareallunderpriced.Thatswhyourportfoliosexpectedreturnwas
higherthanwhatwasjustified,givenitsbeta.Wehavefoundfiveunderpricedstocks!
E. Ofcourse,thisconclusionisbasedonourhavingtherightbetas.Ifallofourbetasunderstate
theirstockssystematicrisks,thenwewouldbeunderestimatingourportfoliorisk.Ifourinputs
areflawed,sowillbeourconclusion(garbagein/garbageout).
821. A.B.
Yourfathersretirementportfoliohasabetaof1.80.Thismeansthateverypercentage
changeinthemarketsreturnismagnified1.8times,movinghisportfolio1.8%.Wecan
seethisfromtheCAPM.Afirmsstocksexpectedreturncanbefoundas:
E(ri)=rriskfree i* [E(rmarket)rriskfree].
Now,ifthemarketsexpectedreturnchanges,thestocksexpectedreturnwill,too:
E(ri)newrriskfree+ i* [E(rmarket)newrriskfree].
Thechangeinthefirmsexpectedreturnisthen:
E(ri)newE(ri){rriskfree i* [E(rmarket)newrriskfree]}{rriskfree i* [E(rmarket)rriskfree]}
i* [E(rmarket)newE(rmarket)].
Thus,wecansimplysubstitute7%and7%forthechangeinmarketexpectedreturnto
findthechangesinyourfathersportfoliosexpectedreturn.
Thus,ifthemarketrisesby7%,yourfathersportfoliowillriseby(1.80)(7%)12.6%.
Ifthemarketfallsby7%,yourfathersportfoliowillfallby(1.80)(7%)12.6%.
Forexample,saythattheriskfreerateis3%andthattheinitialmarketreturnis20%.
Thenyourfathersinitialportfolioreturnis:
E(ri)3%1.80(20%3%)33.6%.
Now,ifthemarketsreturnrisesby7%,to27%,wehave:
E(ri)3%1.80(27%3%)46.2%,
orachangeof(46.2%33.6%)12.6%.Ontheotherhand,ifthemarketfallsby7%to
13%,wehave:
E(ri)3%1.80(13%3%)21.0%,
orachangeof(33.6%21.0%)12.6%.
C. Yourfathersportfolioismuchriskierthanthemarket.Weknowthatbecauseitsbetaismuch
greaterthan1.Thistranslatesintomagnifiedswingsrelativetothemarket.Ifyourfatherisvery
closetoretirement,heshouldseriouslyconsiderloweringtheriskofhisportfoliohewouldnt
haveenoughtimetorecoverfromawildnegativeswing.
822. A. Thebetaofaportfolioisaweightedaverageofthebetasofthesecuritiesintheportfolio.That
is,forourportfolio:
4
portfolio (weighti ) ( i )
i 1
(0.25) (2.5) (0.25) (1.0) (0.25) (0.5) (0.25) ( 1.50)

0.625.
Wecanseethesecalculationsdetailedinthespreadsheetbelow:
B.C. Thus,thisportfolioisdefensive:Itsbetaislessthan1,anditwillswinglessstronglythan
themarket.Forexample,ifthemarketsreturnweretoriseby25%(25percentagepoints,
2500basispoints),yourportfoliosreturnwouldchangeby(0.625)(25%)15.625%;if
themarketfallsby25%,yourportfoliowillfallby15.625%.
D. Sinceportfoliobetaisaweightedaverage,wecouldmosteasilydecreaseyourportfoliosbeta
bydecreasingtheweightofthehighestbetastock,A,andincreasingtheweightinthelowest
betastock,D.Forexample,saywedecreasedAsweightto10%andincreasedDsto40%:
Thisreducestheportfoliobetatoatiny0.025.
Wecanseethiseffectinthegraphbelow.Thisgraphplotsportfoliobetaasafunctionofthe
proportionoftheportfolioinA.The25%weightstoBandCarekeptfixed;theproportioninD
is(50%weightinA).Asweincreasetheweightofthehighbetaasset,A,theportfoliobeta
riseslinearly.
823. A. Thebetaofaportfolioisaweightedaverageofthebetasofthesecuritiesintheportfolio.That
is,forourportfolio:
4
portfolio (weight i ) * ( i )
i 1
Forportfolio1,wehave:
portfolio=(0.10)(2.5)(0.10)(1.0)(0.40)(0.5)(0.40)(1.50)0.05.
Werepeatthesecalculationsforportfolio2,asdetailedinthespreadsheetbelow:
C = A*B
PORTFOLIO 1
security
A
B
C
D
beta
2.50
1.00
0.50
-1.50
percentage
of portfolio
10%
10%
40%
40%
100%
weight*beta
0.250
0.100
0.200
-0.600
-0.050
betaportfolio
E = A*D
PORTFOLIO 2
percentage
of portfolio
40%
40%
10%
10%
100%
weight*beta
1.0
0.4
0.05
-0.15
1.3
betaportfolio
B. Sinceportfolio2sbetaishigherthanthatofportfolio1,2istheriskierportfolio.Thisisnot
surprising,since2weightsthetwohigherbetastocksmoreheavily.(Portfolio1snegativebeta
alsomeansthatitsreturnswillmoveintheoppositedirectionofthemarkets.)
C. Iftheriskfreeratewere4%andthemarketriskpremiumwere5%,wewouldfindtheexpected
returnsforthesetwoportfoliosas:
E(r1)rriskfree A* [E(rmarket)rriskfree]
rriskfree A* [marketriskpremium]
4%0.05[5%]3.75%.
Forportfolio2wehaveahigherexpectedreturn,sinceitsbetaishigherthanthatofportfolio1:
E(r2)=4%1.3[5%]10.5%
824. Iftheriskfreerateis4%andtheexpectedreturnonthemarketis10%,thenthemarketrisk
premium,[E(rmarket)rriskfree]6%.
A.B.
TheSMLisalinebetweentheriskfreerate(0beta,4%return)andthemarketexpected
return(1,10%).Anassetwithabetaof0.40isdefensive;itwillhaveanexpectedreturn
betweentheriskfreereturnandthemarketsexpectedreturn.(Itwillbe4%0.40(6%)
6.4%inthiscase.)Anassetwhosebetais1.8isaggressive;itsexpectedreturnwill
exceedthemarkets(itis4%1.8(6%)14.8%here).Wecanseeallofthesepoints
onthegraphbelow:
C. Iftheinflationratefalls,leavingtheriskfreerateat2%andtheexpectedreturnonthemarketat
8%,themarketriskpremiumremainsat6%(8%2%),buttheSMLshiftsdownparallelto
theoldSMLby200bp:
D. Ifinvestorsbecomemoreriskaverse,leavingtheriskfreerateat4%butincreasingtheexpected
returnonthemarketto12%,thentheslopeoftheSMLwillchange.Themarketriskpremium
is(12%4%)8%.Notethatthehighbetastocknowchangesby360bpinsteadofonly200
(asintheparallelshiftcase);thelowbetastock,ontheotherhand,nowchangesby80bp,
insteadof200.
Wecansummarizeourthreescenariosusingthegraphbelow.Theblacklineshowstheinitial
situation;thelightgraylinebelowit(andparalleltoit)isthesecondscenario,wheretheinflation
premiumlowersallratesby200bp;thedarkgraylineshowsthelastsituation,wheretheincreased
riskaversioncausestheslopeoftheSMLtorise.
825. A. Weownaportfoliowithfivestocks.Theportfolioproportions,betas,andexpectedreturnsfor
thesefivestocksareshownincolumnsE,B,andF,respectively,inthespreadsheetonthenext
page.Wearetofindtheportfolioexpectedreturnandbeta.
Tofindtheportfolioexpectedreturn,wecansolvethefollowing:
5
E (rportfolio ) (weight i ) *[ E (ri )],

i 1
whereiindexesourfivestocks.Thuswehave:
E(rportfolio)(0.10)(12%)(0.25)(11%)(0.15)(15%)(0.30)(9%)(.20)(14%)
11.7%,
whichisbetweentheexpectedreturnsofthestockwiththehighestE(r),15%,andthatwiththe
lowest,9%.
B. WecouldalsohavefoundthisusingtheCAPM.However,forthatmethodwefirstmustfindthe
portfoliosbeta.Asistheexpectedreturn,aportfoliosbetaissimplyaweightedaverageofits
constituentsbetas:
5
portfolio (weight i )( i )
i 1
(0.10) (1) (0.25) (0.75)

(0.15) (1.3) (0.30) (0.60) (0.20) (1.20)
0.9025.
C. Now,wecanusetheequationfortheSML:
E(rportfolio)rriskfree portfolio [E(rmarket)rriskfree]
*
4%0.9025[10%4%]9.415%.
Thisisnotthesame!Itshouldbe.Itisnthere,though,becausetheexpectedreturnsweused
abovearenotconsistentwiththeCAPM,aswewillseebelow.Hadweusedconsistentexpected
returnsforourstocks,wewouldhavefoundthefollowing:
E(rportfolio)(0.10)(10%)(0.25)(8.5%)(0.15)(11.8%)
(0.30)(7.6%)(0.20)(11.2%)
9.415%,
asrequired.Letsseewhatwenthappenedhere.
Thechartbelowlaysitallout.Theexpectedreturnsthatwewouldexpect,giventheCAPM,are
incolumnD.TheactualexpectedreturnsgivenintheproblemarethoseincolumnF.Aswesee
incolumnG,thegivenvaluesareallhigherthanthosewewouldexpectfromtheCAPM.All
fiveofthesestocksareunderpriced!
D. WecanalsoseethisfromtheplotoftheCAPM.AllofthegivenvaluesplotabovetheSML.
Thismeansthattheyareallofferinghigherexpectedreturnsthantheyshouldbe,giventheir
systematicrisks.Thustheyareallunderpriced.Thatswhyourportfoliosexpectedreturnwas
higherthanwhatwasjustified,givenitsbeta.Wehavefoundfiveunderpricedstocks!
E. Ofcourse,thisconclusionisbasedonourhavingtherightbetas.Ifallofourbetasunderstate
theirstockssystematicrisks,thenwewouldbeunderestimatingourportfoliorisk.Ifourinputs
areflawed,sowillbeourconclusion(garbagein/garbageout).
826. Anita,Inc.hasfourinvestmentsthatitisconsidering.Thebetavaluesfortheseinvestmentsare
givenincolumnAinthetablebelow.GiventheTbillrateof4.5%(whichwillbeourproxyforthe
riskfreerate)andtheexpectedreturnofthemarketof11%,wecanusetheCAPMtofindthe
investmentsexpectedreturns:
Forexample,forinvestmentH,wehave:
E(rH)4.5%0.75(11%4.5%)9.375%.
TheotherassetsexpectedreturnsareshownincolumnBbelow,andthenplottedastheSML:
827. A. GraceCorporationhasfourinvestmentsthatitisconsidering.Thebetavaluesfortheseinvestments
aregivenincolumnAinthetablebelow.GiventheTbillrateof2.5%(whichwillbeour
proxyfortheriskfreerate)andtheexpectedreturnofthemarketof9%,wecanusetheCAPM
tofindtheinvestmentsexpectedreturns:
Forexample,forinvestmentK,wehave:
E(rK)2.5%1.12(9%2.5%)9.78%.
TheotherassetsexpectedreturnsareshownincolumnBbelow,andthenplottedastheSML:
B. Iftheriskfreerateweretoriseto4.5%whilethemarketriskpremium(thatis,[E(rmarket)rriskfree])
weretofallto5%(from6.5%above),ourexpectedreturnswouldchangeasfollows:
C. Thetwoscenariosaregraphedbelow.Theflatter,highergraylineisthesecondscenario,with
thehigherriskfreerateandlowermarketriskpremium.Theblacklinerepresentsthefirstscenario,
withthelowerriskfreerateandhighermarketriskpremium.Thisblacklineismorelikelyto
representarecessionaryperiod,whenratesareloweroverall,givenlowerexpectedinflationand
lesseconomicactivity.Thegraylineismorelikelytorepresenttheexpansionaryperiodmore
economicactivitymeanmoredemandforfundsforinvestment,pushingratesup;optimism
meansthatinvestorsriskaversionmaylessen,meaningalowermarketriskpremium.

Part 2 tkm0844 11e Im ch08

Transféré par

Informations du document

Titre original

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

Part 2 tkm0844 11e Im ch08

Transféré par

Droits d'auteur :

Formats disponibles

SolutionstoEndofChapterProblemsChapter8215

E (rportfolio ) (probability i ) * E (return i ),

(100% 18%)2 * (0.05) (35% 18%)2 * (0.45)

E (rportifolio ) (weight i ) E (ri ),

portfolio .0059 0.0771 7.71%.

(0.10)2 (0.12)2 (0.90)2 (0.06)2 2 (0.90) (0.10) (0.12) (0.06) (0.40)

E (rportfolio ) (probability i ) * E(return i ),

(2% 16.6%)2 (0.20) (19% 16.6%)2 (0.50) (25% 16.6%)2 (0.30)

(2% 1.88%)2 (2% 1.88%)2

(1% 2%)2 ( 3% 2%)2

E (rportfolio ) (weight i ) [ E (ri )] ,

(0.20) (1) (0.30) (0.85)

(0.25) (2.5) (0.25) (1.0) (0.25) (0.5) (0.25) ( 1.50)

E (rportfolio ) (weight i ) *[ E (ri )],

(0.10) (1) (0.25) (0.75)

Vous aimerez peut-être aussi