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Chapter: 6
Problem: 15
a. Use the data given to calculate annual returns for Goodman, Landry, and the Market Index, and then
calculate average returns over the five-year period. (Hint: Remember, returns are calculated by
subtracting the beginning price from the ending price to get the capital gain or loss, adding the
dividend to the capital gain or loss, and dividing the result by the beginning price. Assume that
dividends are already included in the index. Also, you cannot calculate the rate of return for 2010
because you do not have 2009 data.)
We now calculate the rates of return for the two companies and the index:
Average
Note: To get the average, you could get the column sum and divide by 5, but you could also use the function
wizard, fx. Click fx, then statistical, then Average, and then use the mouse to select the proper range. Do this
for Goodman and then copy the cell for the other items.
b. Calculate the standard deviation of the returns for Goodman, Landry, and the Market Index. (Hint:
Use the sample standard deviation formula given in the chapter, which corresponds to the STDEV
function in Excel.)
c. Construct a scatter diagram graph that shows Goodman’s and Landry’ returns on the vertical axis
and the Market Index’s returns on the horizontal axis.
It is easiest to make scatter diagrams with a data set that has the X-axis variable in the left
column, so we reformat the returns data calculated above and show it just below.
To make the graph, we first selected the range with the returns and the column heads, then clicked the chart
wizard, then choose the scatter diagram without connected lines. That gave us the data points. We then used
the drawing toolbar to make free-hand ("by eye") regression lines, and changed the lines color and weights to
match the dots.
d. Estimate Goodman’s and Landry’s betas as the slopes of regression lines with stock returns on the
vertical axis (y-axis) and market return on the horizontal axis (x-axis). (Hint: use Excel’s SLOPE
function.) Are these betas consistent with your graph?
Goodman's beta =
Landry' beta =
e. The risk-free rate on long-term Treasury bonds is 6.04%. Assume that the market risk premium is 5%. What is
the expected return on the market? Now use the SML equation to calculate the two companies' required returns.
Market risk premium (RPM) = 5.000%
Risk-free rate = 6.040%
Goodman:
Required return =
=
Landry:
Required return = x
=
f. If you formed a portfolio that consisted of 50% Goodman stock and 50% Landry stock, what would
be its beta and its required return?
The beta of a portfolio is simply a weighted average of the betas of the stocks in the portfolio, so this portfolio's beta
would be:
Portfolio beta =
g. Suppose an investor wants to include Goodman Industries’ stock in his or her portfolio. Stocks A,
B, and C are currently in the portfolio, and their betas are 0.769, 0.985, and 1.423, respectively.
Calculate the new portfolio’s required return if it consists of 25% of Goodman, 15% of Stock A, 40% of
Stock B, and 20% of Stock C.
rtfolio's beta