Assume that your uncle holds just one stock, East Coast Bank (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for West Coast Bank (WCB). Both banks have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would your uncle's risk have been reduced if he had held a portfolio consisting of 73% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.) Do not round your intermediate calculations. ECB 40.00% WCB 40.00% -10.00% 19.00% 35.00% -5.00% -5.00% -10.00% 19.00% 35.00% Year 1 2 3 4 5 Average return = Standard deviation = O a. 5.24 p.p. O b. 0.72 p.p. O c. 2.84 p.p. O d. 0.64 p.p. O e. 3.18 p.p. 15.80% 22.71% 15.80% 22.71%

Assume that your uncle holds just one stock, East Coast Bank (ECB), which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for West Coast Bank (WCB). Both banks have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would your uncle's risk have been reduced if he had held a portfolio consisting of 73% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.) Do not round your intermediate calculations. ECB 40.00% WCB 40.00% -10.00% 19.00% 35.00% -5.00% -5.00% -10.00% 19.00% 35.00% Year 1 2 3 4 5 Average return = Standard deviation = O a. 5.24 p.p. O b. 0.72 p.p. O c. 2.84 p.p. O d. 0.64 p.p. O e. 3.18 p.p. 15.80% 22.71% 15.80% 22.71%

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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You have been asked to calculate the required return for a stock that you are considering investing in. You recently looked up the risk-free rate (as measured by Treasury bonds) and found it to be 1%. You also looked up the current market return of the S&P 500 and found it to be 12. If the firm has a beta of 1.2, what is its required return?
You are concerned about the market volatility but have found stocks that are attractively priced. In additionto cash, your portfolio will have securities both on the LONG and SHORT sides. You want to set up your LONG/SHORT portfolio with some constraints. You will set aside 12.27% of the equity as a cash reserve to cushion any adverse margin changes and to pay any associated fees. You will maximize your buying and selling power (i.e. what you can purchase and sell on margin) using the remaining equity and loans from the broker. Your account's beginning equity is $201,290 all in cash before you start trading. You will set up your 100% beta-neutral trade on full margin, and the margin requirements are 50% on both sides. Assume that the LONG side has a weighted average beta of 1.35, while the SHORT side has a weighted average beta of 1.00. What is the value of your account's total liabilities immediately after you set up the portfolio? O $250,234 $257,185 $264,136 $271,087 $278,038
An antitrust case has lead to you having to calculate a fair return (using the CAPM) for RadioEthiopea common stock. The risk free rate is 3.20%, while the expected return on the market is 4.70%. The shares have a volatility of 21.00%, while the market has a volatility of 13.00%. The correlation between the two sets of returns is 0.44. What is the fair return for RadioEthiopea common stock?
The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2,1% over the coming month. Beta 1.4 Standard Deviation R- of Residuals square 0.65 0.1 (i.e., 10% monthly) Now suppose that the manager misestimates the beta of Waterworks stock, believing it to be 0.5 instead of 1.4. The standard deviation of the monthly market rate of return is 9%. If he holds a $5,000,000 portfolio of Waterworks stock. The S&P 500 currently is at 2,000 and the contract multiplier is $50. a. What is the standard deviation of the (now improperly) hedged portfolio? (Round your answer to 3 decimal places.) Standard deviation % b. What is the probability of incurring a loss on improperly hedged portfolio over the next month if the monthly market return has an expected value of 1% and a standard deviation of 9%? The manager holds a $5 million portfolio of Waterworks…
Choose one appropriate statement. 1. The movement of stock prices have certain patterns, and investors can make profits by studying such patterns. 2. If a hedge fund manager believes that Toyota will going to outperform Honda she will short stocks of both companies. 3. When one share of Apple stock is being traded at $150, the stock market believes that you can always sell a share of Apple stock for at least $150 in the future. 4. O An undervalued stock should outperform the market in the long run. 5. O Diversification is not appropriate because it would prevent investors from capitalizing on the superior return that can result from a concentrated holding of the stock of one successful company.
Stock analyst, Mr. Abhay, is analysing 3 stocks A, B and C having 3 common risk factors. Following data is observed. Assume λ0 as 5%. Calculate return as per APT model. If the expected returns of A, B and C are 13%, 18% and 11% respectively, indicate which stocks are undervalued or overvalued. What will be the implication in terms of arbitrage? Mr. Abhay is also interested in analysing the expected returns as per CAPM model. Risk free rate is 6%. Average Market Return is 19%. The equity beta of A, B and C are 1.1, 0.85 and 0.55 respectively. Calculate the required return as per CAPM and plot the stocks on SML. Indicate if the stocks are undervalued or overvalued if the expected returns are 13%, 18% and 11% respectively for A, B and C. Beta / Sensitivity Factor Risk Premium Stock A Stock B Stock C Management Risk 5.5% 1.5 1.1 0.8 Interest Rate Risk 2.0% 0.8 0.5 0.4 Inflation Risk 3.5% 0.5 0.9 0.7
Some investors use the Sharpe ratio as a way of comparing the benefits of owning shares of stock in a company to the risks. The Sharpe ratio of a stock is defined as the ratio of the difference between the mean return on the stock and the mean return on government bonds (called the risk-free rate rf ) to the SD of the returns on the stock. The mean return on government bonds is rf = 0.03% per day. The table below describes the daily return of three stocks. Date APPLE. TESLA GM 01/10/20 0.85% 4.46% 2.67% 02/10/20 -3.23% - 7.38% 0.26% 05/10/20 3.08% 2.55% 1.64% 06/10/20 -2.87% -2.75% -1.81% 07/10/20 1.70% 2.73% 4.01% 08/10/20 -0.10% 0.15% 1.87% 09/10/20 1.74% 1.90% -0.16% 12/10/20 6.35% 1.91% 0.16% 13/10/20 -2.65% 0.98% -1.06% 14/10/20 0.07% 3.28% -0.63% 15/10/20 -0.40% -2.69% 2.90% 16/10/20 -1.40% -2.05%…
6) An investor holds a portfolio of stocks and is considering investing in the DBB Company. The firm's prospects look neutral, and you estimate the following probability distribution of possible returns: Conditions Recession P Returns on DBB Returns on DVI 0.12 -33% -12% Below Average 0.15 -18% 7% Average 0.46 12% 11% Above Average 0.15 25% 23% Boom 0.12 37% 25% a) How much is the expected return for DBB? b) How much is the coefficient of variation for DBB? c) Now let's say you want to add another asset, DVI, to your portfolio. You sell 35% of DBB to purchase DVI. How much is your expected return for this portfolio? d) How much is the coefficient of variation for the new portfolio?
Although investing all at once works best when stock prices are rising, dollar-cost averaging can be a good way to take advantage of a fluctuating market. Dollar-cost averaging is an investment strategy designed to reduce volatility in which securities are purchased in fixed dollar amounts at regular intervals regardless of what direction the market is moving. This strategy is also called the constant dollar plan. You are considering a hypothetical $1,200 investment in a media company's stock. Your choice is to invest the money all at once or dollar-cost average at the rate of $100 per month for one year. Assume that the company allows you to purchase "fractional" shares of its stock. (a) If you invested all of the money in January and bought the shares for $12 each, how many shares could you buy? shares (b) From the following chart of share prices, calculate the number of shares that would be purchased each month using dollar-cost averaging and the total shares for the year. Round to…
H. As a new analyst, you have obtained the prices for the stocks of both Lulu and Lemon. Both stocks did not paid any dividends during the entire period. (1) (II) (III) Your manager has asked you (i) to compute the rate of return and standard deviation of the two stocks and suggest that because these companies produce similar products, you should continue your analysis by (ii) computing their covariance and correlation. Show all calculations. Year 2019 2020 2021 2022 2023 Closing prices of LuLu Closing prices of Lemon 20.50 30.10 19.92 28.50 22.45 30.10 24.50 40.30 20.50 36.40 Compute the return and standard deviation of a portfolio with 60% investment in Lulu and 40% in Lemon. Would you recommend putting these two stocks together in a portfolio? Explain why or why not.
2B) You have $600,000 to invest in the stock market. Suppose you invested one-third of your wealth in stock Q and the rest in stock L. These stocks have the following characteristics: Stock Q has an expected return of 10% and a standard deviation of 7%. Stock L has an expected return of 18% and a standard deviation of 11%. Determine the expected return and standard deviation on a portfolio of stocks Q and L, when the two stocks are uncorrelated and when they are negatively perfectly correlated. Interpret and compare your answers in these two cases.
You are evaluating the expected performance of two stocks, Alibaba and Bank of China.You gathered the following informationRisk-free rate = 5%Expected return for a Hong Kong market = 11.5%Beta of Alibaba = 1.5Beta of Bank of China = 0.8 Based on your analysis, you forecast the return on these 2 stocks are 13.25% for Alibaba and11.25% for Bank of China.i) Calculate the required rate of return for Alibaba and Bank of Chinaii) Indicate whether each stock is undervalued, fairly valued or overvalued.

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