CORPORATE FINANCE
CORPORATE FINANCE
12th Edition
ISBN: 9781307702804
Author: Ross
Publisher: MCG/CREATE
Question
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Chapter 11, Problem 35QAP

a.

Summary Introduction

Adequate information:

    StateProbability of OutcomeReturn on Security 1Return on Security 2Return on Security 3
    10.150.200.200.05
    20.350.150.100.10
    30.350.100.150.15
    40.150.050.050.20

To compute: The expected return and standard deviation of Security 1, Security 2, and Security 3.

Introduction: Expected return simply refers to the return that is anticipated on the investment.

b.

Summary Introduction

Adequate information:

    StateProbability of OutcomeReturn on Security 1Return on Security 2Return on Security 3
    10.15 0.200.200.05
    20.350.150.100.10
    30.350.100.150.15
    40.150.050.050.20

To compute: The covariance and correlations between the securities.

Introduction: The relationship between two securities is referred to as covariance.

c.

Summary Introduction

Adequate information:

    StateProbability of OutcomeReturn on Security 1Return on Security 2Return on Security 3
    10.150.200.200.05
    20.350.150.100.10
    30.350.100.150.15
    40.150.050.050.20

Weight of security 1 (W1) = 50% or 0.50

Weight of security 2 (W2) = 50% or 0.50

Expected return of Security 1 [E(R1)] = 0.1250 or 12.50%

Expected return of Security 2 [E(R2)] = 0.1250 or 12.50%

Standard deviation of Security 1 (σ1) = 0.0461 or 4.61%

Standard deviation of Security 2 (σ2) = 0.0461 or 4.61%

Correlation between Security 1 and Security 2 (?1,2) = 0.59

To compute: The expected return and standard deviation of a portfolio if half of the funds are invested in Security 1 and a half in Security 2.

Introduction: Expected return on the portfolio refers to the return that is anticipated on the portfolio as a whole.

d.

Summary Introduction

Adequate information:

    StateProbability of OutcomeReturn on Security 1Return on Security 2Return on Security 3
    10.150.200.200.05
    20.350.150.100.10
    30.350.100.150.15
    40.150.050.050.20

Weight of security 1 (W1) = 50% or 0.50

Weight of security 3 (W3) = 50% or 0.50

Expected return of Security 1 [E(R1)] = 0.1250 or 12.50%

Expected return of Security 2 [E(R3)] = 0.1250 or 12.50%

Standard deviation of Security 1 (σ1) = 0.0461 or 4.61%

Standard deviation of Security 2 (σ3) = 0.0461 or 4.61%

Correlation between Security 1 and Security 3 (?1,3) = -1

To compute: The expected return and standard deviation of a portfolio if half of the funds are invested in Security 1 and half in Security 3.

Introduction: Expected return on the portfolio refers to the return that is anticipated on the portfolio as a whole.

e.

Summary Introduction

Adequate information:

    StateProbability of OutcomeReturn on Security 1Return on Security 2Return on Security 3
    10.150.200.200.05
    20.350.150.100.10
    30.350.100.150.15
    40.150.050.050.20

Weight of security 2 (W2) = 50% or 0.50

Weight of security 3 (W3) = 50% or 0.50

Expected return of Security 2 [E(R2)] = 0.1250 or 12.50%

Expected return of Security 3 [E(R3)] = 0.1250 or 12.50%

Standard deviation of Security 2 (σ2) = 0.0461 or 4.61%

Standard deviation of Security 3 (σ3) = 0.0461 or 4.61%

Correlation between Security 2 and Security 3 (?2,3) = -0.59

To compute: The expected return and standard deviation of a portfolio if half of the funds are invested in Security 2 and a half in Security 3.

Introduction: Expected return on the portfolio refers to the return that is anticipated on the portfolio as a whole.

f.

Summary Introduction

Adequate information:

    StateProbability of OutcomeReturn on Security 1Return on Security 2Return on Security 3
    10.150.200.200.05
    20.350.150.100.10
    30.350.100.150.15
    40.150.050.050.20

To compute: About diversification by considering Parts (a), (c), (d), (e).

Introduction: Correlation defines how two or more securities in the portfolio are related to each other.

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CORPORATE FINANCE

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