Consider the following information about the various states of economy and the returns of various investment alternatives for each scenario. Answer the questions that follow. % Return on T-Bills, Stocks and Market Index State of the Economy Probability T- Phillips Pay- Rubber- Market Bills up made Index Recession 0.2 7 -22 28 10 -13 Below Average 0.1 7 -2 14.7 -10 1 Average 0.3 7 20 0 7 15 Above Average 0.3 7 35 -10 45 29 Boom 0.1 7 50 -20 30 43 Mean Standard Deviation Coefficient of Variation Covariance with MP Correlation with Market Index Beta CAPM Req. Return Valuation (Overvalued/Undervalued/Fairly Valued) Nature of stock (Aggressive/Defensive) Question 1a. Fill the parts in the above table that are shaded in yellow. You will notice that there are nine line items. Question 1b. Using the data generated in the previous question (Question 1a); a) Plot the Security Market Line (SML) b) Superimpose the CAPM’s required return on the SML c) Indicate which investments will plot on, above and below the SML? d) If an investment’s expected return (mean return) does not plot on the SML, what does it show? Identify undervalued/overvalued investments from the graph Question 1c. From the information generated in the previous two questions; a) Identify two investment alternatives that can be combined in a portfolio. Assume a 50- 50 investment allocation in each investment alternative b) Compute the expected return of the portfolio thus formed c) Compute the portfolio’s beta. Is the portfolio aggressive or defensive?

Consider the following information about the various states of economy and the returns of various investment alternatives for each scenario. Answer the questions that follow. % Return on T-Bills, Stocks and Market Index State of the Economy Probability T- Phillips Pay- Rubber- Market Bills up made Index Recession 0.2 7 -22 28 10 -13 Below Average 0.1 7 -2 14.7 -10 1 Average 0.3 7 20 0 7 15 Above Average 0.3 7 35 -10 45 29 Boom 0.1 7 50 -20 30 43 Mean Standard Deviation Coefficient of Variation Covariance with MP Correlation with Market Index Beta CAPM Req. Return Valuation (Overvalued/Undervalued/Fairly Valued) Nature of stock (Aggressive/Defensive) Question 1a. Fill the parts in the above table that are shaded in yellow. You will notice that there are nine line items. Question 1b. Using the data generated in the previous question (Question 1a); a) Plot the Security Market Line (SML) b) Superimpose the CAPM’s required return on the SML c) Indicate which investments will plot on, above and below the SML? d) If an investment’s expected return (mean return) does not plot on the SML, what does it show? Identify undervalued/overvalued investments from the graph Question 1c. From the information generated in the previous two questions; a) Identify two investment alternatives that can be combined in a portfolio. Assume a 50- 50 investment allocation in each investment alternative b) Compute the expected return of the portfolio thus formed c) Compute the portfolio’s beta. Is the portfolio aggressive or defensive?

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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Question

Consider the following information about the various states of economy and the returns of various investment alternatives for each scenario. Answer the questions that follow.

			% Return on T-Bills, Stocks and Market
							Index

State of the Economy	Probability		T-		Phillips		Pay-	Rubber-	Market
	Bills			up		made			Index


Recession	0.2	7	-22	28		10		-13

Below Average	0.1	7	-2	14.7		-10		1

Average	0.3	7	20	0		7		15

Above Average	0.3	7	35	-10		45		29

Boom	0.1	7	50	-20		30		43

Mean

Standard Deviation

Coefficient of Variation

Covariance with MP

Correlation with Market Index

Beta
CAPM Req. Return

Valuation
(Overvalued/Undervalued/Fairly
Valued)
Nature of stock
(Aggressive/Defensive)

Question 1a. Fill the parts in the above table that are shaded in yellow. You will notice that there are nine line items.

Question 1b. Using the data generated in the previous question (Question 1a);

a)	Plot the Security Market Line (SML)
b)	Superimpose the CAPM’s required return on the SML
c)	Indicate which investments will plot on, above and below the SML?
d)	If an investment’s	expected return (mean return) does not plot on the SML, what does
	it show? Identify	undervalued/overvalued investments from the graph

Question 1c. From the information generated in the previous two questions;

a)	Identify two investment	alternatives that can be combined in a portfolio.	Assume a 50-
	50 investment allocation	in each investment	alternative
b)	Compute	the expected return of the portfolio	thus formed
c)	Compute	the portfolio’s	beta. Is the portfolio	aggressive or defensive?

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