Integrated Case: Risk and Return
Integrated Case
8-23
Merrill Finch Inc.
Risk and Return
Assume that you recently graduated with a major in finance. You just landed a job as a financial planner with Merrill Finch Inc., a large financial services corporation. Your first assignment is to invest $100,000 for a client. Because the funds are to be invested in a business at the end of 1 year, you have been instructed to plan for a 1-year holding period. Further, your boss has restricted you to the investment alternatives in the following table, shown with their probabilities and associated outcomes. (For now, disregard the items at the bottom of the data; you will fill in the blanks later.)
Returns on Alternative Investments
Estimated Rate of Return
State of the
Economy
Prob.
Recession
Below Avg.
Average
Above Avg.
Boom
0.1
0.2
0.4
0.2
0.1
r r-hat ( ˆ )
Std. dev. ()
Coeff. of Var. (CV) beta (b)
T-Bills
5.5%
5.5
5.5
5.5
5.5
High
Tech
-27.0%
-7.0
15.0
30.0
45.0
Collections
27.0%
13.0
0.0
-11.0
-21.0
1.0%
0.0
13.2
13.2
-0.87
U.S.
Rubber
6.0%a
-14.0
3.0
41.0
26.0
9.8%
18.8
1.9
0.88
Market
Portfolio
2-Stock
Portfolio
-17.0%
-3.0
10.0
25.0
38.0
0.0%
7.5
12.0
10.5%
15.2
1.4
3.4
0.5
a
Note that the estimated returns of U.S. Rubber do not always move in the same direction as the overall economy. For example, when the economy is below average, consumers purchase fewer tires than they would if the economy were stronger. However, if the economy is in a flat-out recession, a large number of consumers who were planning to purchase a new car may choose to wait and instead purchase new tires for the car they currently own. Under these circumstances, we would expect U.S. Rubber’s stock price to be higher if there was a recession than if the economy was just below average.
Chapter 8: Risk and Rates of Return
Integrated Case
1
Merrill Finch’s economic forecasting staff has
8-23
Merrill Finch Inc.
Risk and Return
Assume that you recently graduated with a major in finance. You just landed a job as a financial planner with Merrill Finch Inc., a large financial services corporation. Your first assignment is to invest $100,000 for a client. Because the funds are to be invested in a business at the end of 1 year, you have been instructed to plan for a 1-year holding period. Further, your boss has restricted you to the investment alternatives in the following table, shown with their probabilities and associated outcomes. (For now, disregard the items at the bottom of the data; you will fill in the blanks later.)
Returns on Alternative Investments
Estimated Rate of Return
State of the
Economy
Prob.
Recession
Below Avg.
Average
Above Avg.
Boom
0.1
0.2
0.4
0.2
0.1
r r-hat ( ˆ )
Std. dev. ()
Coeff. of Var. (CV) beta (b)
T-Bills
5.5%
5.5
5.5
5.5
5.5
High
Tech
-27.0%
-7.0
15.0
30.0
45.0
Collections
27.0%
13.0
0.0
-11.0
-21.0
1.0%
0.0
13.2
13.2
-0.87
U.S.
Rubber
6.0%a
-14.0
3.0
41.0
26.0
9.8%
18.8
1.9
0.88
Market
Portfolio
2-Stock
Portfolio
-17.0%
-3.0
10.0
25.0
38.0
0.0%
7.5
12.0
10.5%
15.2
1.4
3.4
0.5
a
Note that the estimated returns of U.S. Rubber do not always move in the same direction as the overall economy. For example, when the economy is below average, consumers purchase fewer tires than they would if the economy were stronger. However, if the economy is in a flat-out recession, a large number of consumers who were planning to purchase a new car may choose to wait and instead purchase new tires for the car they currently own. Under these circumstances, we would expect U.S. Rubber’s stock price to be higher if there was a recession than if the economy was just below average.
Chapter 8: Risk and Rates of Return
Integrated Case
1
Merrill Finch’s economic forecasting staff has