Homework ES 1. (TCO 8) The historical returns on large-company stocks, as reported by Ibbotson and Sinquefield, are based on: (Points : 3) the largest 20 percent of the stocks traded on the NYSE. the stocks of the largest 10 percent of the publicly traded firms in the U.S. all of the stocks listed on the NYSE.

the stocks of the 500 companies included in the S&P 500 index.

2. (TCO 8) If the financial markets are efficient, then: (Points : 3) stock prices should never change.
stock prices should only respond to unexpected news and events. stock prices should increase or decrease slowly as new events are analyzed and the information is absorbed by the markets. stock prices will only change when an event actually occurs, not at the time the event is anticipated.

3. (TCO 8) Which of the following factors will affect the expected rate of return on a security? Select all that apply: (Points : 4) multiple states of the economy
probability of occurrence for any one economic state market rate of return given a particular economic state security beta

4. (TCO 8) Assume a project that has the following returns for years 1 to 5: 15%, 4%, -13%, 34%, and 17%. What is the approximate variance of this investment? (Points : 3) 0.03
0.15
17%
20%

5. (TCO 8) Assume you are considering investing in two stocks, A & B. Stock A has an expected return of 16% and Stock B has an expected return of 9.5%. Your goal is to create a two-security portfolio that will have an expected return of 12%. If you have $250,000 to invest today, which of the following statements is true? (Points : 3) You would invest more in Stock A than you would invest in Stock B You would invest approximately $96,000 in Stock A and $154,000 in Stock B You would invest the same amount in each stock

...beta of 1.6 and a
risk-free asset. How much should you invest in the risk-free asset?
a. $0
b. $140
c. $200
d. $320
e. $400
ANALYZING A PORTFOLIO
d 59. You have a $1,000 portfolio which is invested in stocks A and B plus a risk-free asset.
$400 is invested in stock A. Stock A has a beta of 1.3 and stock B has a beta of .7.
How much needs to be invested in stock B if you want a portfolio beta of .90?
a. $0
b. $268
c. $482
d. $543
e. $600
EXPECTED RETURN
c 60. You recently purchased a stock that is expected to earn 12 percent in a booming economy, 8 percent in a normal economy and lose 5 percent in a recessionary economy. There is a 15 percent probability of a boom, a 75 percent chance of a normal economy, and a 10 percent chance of a recession. What is your expected rate of return on this stock?
a. 5.00 percent
b. 6.45 percent
c. 7.30 percent
d. 7.65 percent
e. 8.30 percent
EXPECTED RETURN
a 61. The Inferior Goods Co. stock is expected to earn 14 percent in a recession, 6 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a boom is 20 percent while the probability of a normal economy is 55 percent and the chance of a recession is 25 percent. What is the expected rate of return on this stock?
a. 6.00 percent
b. 6.72 percent...

...themselves to risk. Your personality and lifestyle play a big role in how much risk you are comfortably able to take on. If you invest in stocks and have trouble sleeping at night, you are probably taking on too much risk. Risk is defined as the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment.
A financial decision typically involves risk. For example, a company that borrows money faces the risk that interest rates may change, and a company that builds a new factory faces the risk that product sales may be lower than expected. These and many other decisions involve future cash flows that are risky. Investors generally dislike risk, but they are also unable to avoid it.
To make effective financial decisions, managers need to understand what causes risk, how it should be measured and the effect of risk on the rate of return required by investors. These issues are discussed in this chapter using the framework of portfolio theory, which shows how investors can maximize the expected return on a portfolio of risky assets for a given level of risk. The relationship between risk and expected return is first described by the capital asset pricing model...

...a. What are investment returns? What is the return on an investment that costs $1,000 and is sold after 1 year for $1,100?
Investment returns is the expectation of earning money in the future on the amount of money invested. The return is the financial performance of the investment. The return is the difference between the amount invested and the amount you are returned after said investment.
There are two ways to show return on investment.
1. By dollar return.
Amount to be received – Amount invested
= $1,100 - $1,000 = $100 in return
The problems with expressing returns in dollars, you don’t know the size of the investment for that dollar return and you don’t know the timing of the return.
2. Rate of Return or percentage returns
Amount received – Amount invested / Amount invested
= $100 / $1000 = .10 = 10%
The rate of return “standardizes” the dollar return by considering the timing
b. (1) Why is the T-bill’s return independent of the state of the economy? Do T-bill’s promise a completely risk-free return? (2)Why are Alta Industries’s returns expected to move with the economy whereas Repo Men’s are expected to move counter to the economy?
(1) The...

...the context of a portfolio, the risk of an asset is divided into two parts: diversifiable risk (unsystematic risk) and market risk (systematic risk). Diversifiable risk arises from company-specific factors and hence can be washed away through diversification. Market risk stems from general market movements and hence cannot be diversified away. For a diversified investor what matters is the market risk and not the diversifiable risk. (4)In general, investors are risk-averse. So, they want to be compensated for bearing market risk. In a well-ordered market there is a linear relationship between market risk and expected return. (1) RISK AND RETURN OF A SINGLE ASSET: Capital gains/ loss yield Current Yield Rate of Return=[Annual income/Beginning price]+[{Ending price-Beginning price}/ Beginning price] OR Total return = Dividend + Capital gain=
Rate of return Dividend yield Capital gain yield R1 DIV1 P1 P DIV1 P P 0 0 1 P P P 0 0 0
(2) PROBABILITY DISTRIBUTION AND EXPECTED RATE OF RETURN: E(R)=∑(i=1 to n)=p(i) *R(i), where, E(R)=expected return, n=number of possible outcomes, p(i)=probability associated with R(i), R(i)=return for the ith possible outcome....

...RISK & RETURN
TOPIC 4
Learning Objectives
1. Understand the meaning of risk and return
2. Identify risk and return relationship
3. Discuss the measurement of expected return
and standard deviation
4. Understand portfolio and diversification
5. Distinguish the different types of investment
risks
6. Measurement of return based on CAPM
WRMAS
2RETURN DEFINED
• Return represents the total gain or loss on an investment.
•
Basic concept:
Each investor desires a return for every single dollar of their
investment.
Example 1:
Rita invests in 10 unit shares valued at RM1000. At the end of
year, she sells all the shares @ RM1100. How much return
received by Rita for her investment?
RM100 (Holding return dollar gain)
r = RM1,100 + 0 – RM1,000
RM1,000
= 10% (so holding period rate of return is 10%)
WRMAS
3
Return Defined
Exercise 1
Calculate the holding period rate of return of each
quarter below.
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
Dividend
0.50
1.20
0
1.95
Purchase price
100
98
101
102
Selling Price
98
101
102
108
HP Rate of
Return
?
?
?
?
WRMAS
4
EXPECTED RETURN
• Expected...

...expected return on a risky asset.
c. the expected return on a collection of risky assets.
d. the variance of returns for a risky asset.
e. the standard deviation of returns for a collection of risky assets.
PORTFOLIO WEIGHTS
2. The percentage of a portfolio’s total value invested in a particular asset is called that asset’s:
a. portfolio return.
b. portfolio weight.
c. portfoliorisk.
d. rate of return.
e. investment value.
SYSTEMATIC RISK
3. Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk.
a. idiosyncratic
b. diversifiable
c. systematic
d. asset-specific
e. total
UNSYSTEMATIC RISK
4. Risk that affects at most a small number of assets is called _____ risk.
a. portfolio
b. undiversifiable
c. market
d. unsystematic
e. total
PRINCIPLE OF DIVERSIFICATION
5. The principle of diversification tells us that:
a. concentrating an investment in two or three large stocks will eliminate all of your risk.
b. concentrating an investment in three companies all within the same industry will greatly reduce your overall risk.
c. spreading an investment across five diverse companies will not lower your...

...Risk and ReturnAssignment Questions
1. Suppose a stock begins the year with a price of $25 per share and ends with a price of $35 per share. During the year it paid a $2 dividend per share. What are its dividend yield, its capital gain, and its total return for the year?
2. An investor receives the following dollar returns a stock investment of $25:
$1.00 of dividends
Share price rise of $2.00
Calculate the investor’s total return.
3. Below are the probabilities for the economy’s five possible states next year, with the corresponding returns on the market and on Trebli, Inc., stock
Economic Condition
Probability
Market Return
Trebli Return
Rapid expansion
0.12
0.23
0.12
Moderate expansion
0.40
0.18
0.09
No growth
0.25
0.15
0.05
Moderate contraction
0.15
0.09
0.01
Serious contraction
0.08
0.03
-0.02
a. What is the expected return on the market?
b. What is the expected return on the Trebli stock?
4. Tabulated below are the returns from 1935 through 1939 on small-company stocks and on the large-company common stocks.
Year
Small Company Stocks (%)
Large Company Common Stocks (%)
1935
47.7
46.9
1936
33.9
32.4
1937
-35.0
-35.7
1938
31.0
32.3
1939
-0.5
-1.5
a. Calculate the average return for the small company stocks and large...

...Risk and Return Analysis Paper
FIN 402
Risk and Return Analysis Paper
Creating the right balance of securities in a diversified portfolio is crucial to maximizing return and minimize risk. This can be done through analysis of current and past activity of each product. Through a risk assessment, return analysis, researching the beta of each security, and reviewing the average risk and return, we can determine the weights of our securities and devise the strongest portfolio to limit risk and maximize return. As a team, we decided to remain with our original five investments; Ford, Microsoft, The Home Depot, Procter & Gamble, and UPS to create a strong diversified portfolio that will meet our expectations.
Risk Assessment and Return Analysis
The risk assessment and return analysis should be performed for each of the companies in the investment portfolio. Since the companies in the portfolio belong to different industries there should be a good balance in the risk taken and returns. When one company’s stock goes down the others should not suffer. The returns of the other companies would help to cover the loss of the suffering company. UPS is a part of the Air delivery and freight service...