Risk Management Problem, Set 1
Risk Management Problem, Set I
T Blount
FIN/415
Brenda Papillon
May 6, 2013
6-1. (Expected rate of return and risk) Carter Inc. is evaluating a security. One-year Treasury bills are currently paying 9.1 percent. Calculate the investment's expected return and its standard deviation. Should Carter invest in the security?
Probability Return .15 6% .30 9% .40 10% .15 15%
Expected Rate of Return: (.15 x .06) + (.30 x .09) + (.40 x .1) + (.15 x .15) .009 + .027 + .04 + .0225=.0985 or 9.85% Standard Deviation:√((.15)(.06 x .0985) 2 + (.30)(.09 x .0985)2 + (.40)(.10 x .0985)2 + (.15) (.15 x .0985)) = √.0023 = .0479583 or 4.8% I would suggest for Carter to invest in the security. The expected rate of return is higher than the One-year Treasury. In order to invest in the security Carter will have to take a risk. Risk is always involved with investing. The treasury is set and more reliable than the security. I would suggest investing in the security. 10-15. (Risk-adjusted discount rates and risk classes) The G. Wolfe Corporation is examining two capital-budgeting projects with 5-year lives. The first, project A, is a replacement project; the second, project B, is a project unrelated to current operations. The G. Wolfe Corporation uses the risk- adjusted discount rate method and groups projects according to purpose, and then it uses a required rate of return or discount rate that has been preassigned to that purpose or risk class. The expected cash flows for these projects are given here: Project A Project B Initial investment -$250,000 -$400,000 Cash inflows: Year 1 $130,000 $135,000 Year 2 40,000 135,000 Year 3 50,000 135,000 Year 4 90,000 135,000 Year 5 130,000 135,000 The purpose/risk classes and preassigned required rates of return are as follows: Purpose Required Rate of Return Replacement decision 12% Modification or
T Blount
FIN/415
Brenda Papillon
May 6, 2013
6-1. (Expected rate of return and risk) Carter Inc. is evaluating a security. One-year Treasury bills are currently paying 9.1 percent. Calculate the investment's expected return and its standard deviation. Should Carter invest in the security?
Probability Return .15 6% .30 9% .40 10% .15 15%
Expected Rate of Return: (.15 x .06) + (.30 x .09) + (.40 x .1) + (.15 x .15) .009 + .027 + .04 + .0225=.0985 or 9.85% Standard Deviation:√((.15)(.06 x .0985) 2 + (.30)(.09 x .0985)2 + (.40)(.10 x .0985)2 + (.15) (.15 x .0985)) = √.0023 = .0479583 or 4.8% I would suggest for Carter to invest in the security. The expected rate of return is higher than the One-year Treasury. In order to invest in the security Carter will have to take a risk. Risk is always involved with investing. The treasury is set and more reliable than the security. I would suggest investing in the security. 10-15. (Risk-adjusted discount rates and risk classes) The G. Wolfe Corporation is examining two capital-budgeting projects with 5-year lives. The first, project A, is a replacement project; the second, project B, is a project unrelated to current operations. The G. Wolfe Corporation uses the risk- adjusted discount rate method and groups projects according to purpose, and then it uses a required rate of return or discount rate that has been preassigned to that purpose or risk class. The expected cash flows for these projects are given here: Project A Project B Initial investment -$250,000 -$400,000 Cash inflows: Year 1 $130,000 $135,000 Year 2 40,000 135,000 Year 3 50,000 135,000 Year 4 90,000 135,000 Year 5 130,000 135,000 The purpose/risk classes and preassigned required rates of return are as follows: Purpose Required Rate of Return Replacement decision 12% Modification or