Fundamentals of Corporate Finance
11th Edition
ISBN: 9780077861704
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Bradford D Jordan Professor
Publisher: McGraw-Hill Education
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Chapter 13, Problem 5CRCT
Summary Introduction
To discuss: Whether the portfolio expected return could be less than or greater than the expected
Introduction:
Expected return refers to the return that the investors expect on a risky investment in the future. Portfolio expected return is the return expected by the investors on a portfolio of assets.
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Suppose you observe the following situation:Security Beta Expected ReturnDiamond Co 1.3 0.2Spade Co 0.8 0.14 (a) According to the above information, could we figure out the market return and risk-free rate? Explain your answer. (b) Discuss the possibility of including zero beta or negative beta assets in your portfolio. Explain the pros and cons of including these types of assets.
Assume a utility function of ? = ?[?] − 1 ?? 2. Which statement(s) is/are correct about investors with this utility function?
[I] An investor with a higher degree of risk aversion chooses the optimal portfolio with a higher risk premium
[II] An investor with a higher degree of risk aversion chooses the optimal portfolio with lower risk
[III] An investor with a higher degree of risk aversion chooses the optimal portfolio with a higher sharpe ratio
[IV] The extent to which the investor dislikes risk is captured by ? 2
A. [II] only
B. [I], [II] only
C. [III] , [IV] only
D. [II], [IV] only
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H2.
What are the different types of expected return and related risk, for individual assets and for portfolios as a whole. Explain carefully what each type represents and give examples in each case. What type of expected returns does the CAPM model capture? What type of expected return and risk you are exposed to if you have the FTSE 100 INDEX only in the portfolio?
Chapter 13 Solutions
Fundamentals of Corporate Finance
Ch. 13.1 - How do we calculate the expected return on a...Ch. 13.1 - In words, how do we calculate the variance of the...Ch. 13.2 - What is a portfolio weight?Ch. 13.2 - How do we calculate the expected return on a...Ch. 13.2 - Is there a simple relationship between the...Ch. 13.3 - What are the two basic parts of a return?Ch. 13.3 - Under what conditions will a companys announcement...Ch. 13.4 - Prob. 13.4ACQCh. 13.4 - Prob. 13.4BCQCh. 13.5 - What happens to the standard deviation of return...
Ch. 13.5 - What is the principle of diversification?Ch. 13.5 - Why is some risk diversifiable? Why is some risk...Ch. 13.5 - Why cant systematic risk be diversified away?Ch. 13.6 - Prob. 13.6ACQCh. 13.6 - What does a beta coefficient measure?Ch. 13.6 - True or false: The expected return on a risky...Ch. 13.6 - How do you calculate a portfolio beta?Ch. 13.7 - Prob. 13.7ACQCh. 13.7 - What is the security market line? Why must all...Ch. 13.7 - Prob. 13.7CCQCh. 13.8 - If an investment has a positive NPV, would it plot...Ch. 13.8 - What is meant by the term cost of capital?Ch. 13 - Prob. 13.1CTFCh. 13 - Prob. 13.5CTFCh. 13 - Beta is a measure of what?Ch. 13 - The slope of the security market line is equal to...Ch. 13 - Where would a negative net present value project...Ch. 13 - Prob. 1CRCTCh. 13 - Prob. 2CRCTCh. 13 - Systematic versus Unsystematic Risk [LO3] Classify...Ch. 13 - Systematic versus Unsystematic Risk [LO3] Indicate...Ch. 13 - Prob. 5CRCTCh. 13 - Diversification [LO2] True or false: The most...Ch. 13 - Portfolio Risk [LO2] If a portfolio has a positive...Ch. 13 - Beta and CAPM[LO4] Is it possible that a risky...Ch. 13 - Corporate Downsizing [LO1] In recent years, it has...Ch. 13 - Earnings and Stock Returns [LO1] As indicated by a...Ch. 13 - Determining Portfolio Weights [LO1] What are the...Ch. 13 - Portfolio Expected Return [LO1] You own a...Ch. 13 - Portfolio Expected Return [LO1] You own a...Ch. 13 - Prob. 4QPCh. 13 - Prob. 5QPCh. 13 - Prob. 6QPCh. 13 - Calculating Returns and Standard Deviations [LO1]...Ch. 13 - Calculating Expected Returns [LO1] A portfolio is...Ch. 13 - Returns and Variances [LO1] Consider the following...Ch. 13 - Returns and Standard Deviations [LO1] Consider the...Ch. 13 - Calculating Portfolio Betas [LO4] You own a stock...Ch. 13 - Calculating Portfolio Betas [LO4] You own a...Ch. 13 - Using CAPM[LO4] A stock has a beta of 1.15, the...Ch. 13 - Using CAPM[LO4] A stock has an expected return of...Ch. 13 - Using CAPM [LO4] A stock has an expected return of...Ch. 13 - Using CAPM [LO4] A stock has an expected return of...Ch. 13 - Using the SML[LO4] Asset W has an expected return...Ch. 13 - Reward-to-Risk Ratios [LO4] Stock Y has a beta of...Ch. 13 - Reward-to-Risk Ratios [LO4] In the previous...Ch. 13 - Using CAPM [LO4] A stock has a beta of 1.14 and an...Ch. 13 - Portfolio Returns [LO2] Using information from the...Ch. 13 - Prob. 22QPCh. 13 - Portfolio Returns and Deviations [LO2] Consider...Ch. 13 - Analyzing a Portfolio [LO2, 4] You want to create...Ch. 13 - Analyzing a Portfolio [LO2, 4] You have 100,000 to...Ch. 13 - Systematic versus Unsystematic Risk [LO3] Consider...Ch. 13 - SML [LO4] Suppose you observe the following...Ch. 13 - SML [LO4] Suppose you observe the following...Ch. 13 - Prob. 1MCh. 13 - Beta is often estimated by linear regression. A...Ch. 13 - Prob. 3MCh. 13 - Prob. 4MCh. 13 - Prob. 5M
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- Suppose you have an investment portfolio with fraction x invested in a market portfolio and (1-x) in a risk- free asset. Increasing fraction x invested in the market portfolio and consequently decreasing (1-x) invested in the risk-free asset shall (select any correct answer, if there are multiple correct answers) Select one or more: O decrease the Sharpe ratio of the resulting portfolio O decrease the expected return of the resulting portfolio increase the Sharpe ratio of the resulting portfolio increase the expected return of the resulting portfolio Dincrease the risk of the resulting portfolioarrow_forward* Consider the following portfolio II: long one call with exercise price E₁, long one put with exercise price E2, short one call with exercise price E, and short one put with exercise price E1+E2 E. Consider the case E₁ < E < E2 where E < 2 ⚫ (a) Write down the pay-off function A(S) for the portfolio II. • • (b) What is the value of the pay-off function when S < E₁? (c) What is the value of the pay-off function when E < S < E₂?arrow_forwardWe believe that the single factor model can predict any individual asset’s realized rate of return well. Both Portfolio A and Portfolio B are well-diversified: ri = E(ri) + βiF + Ei, where E(ei) = 0 and Cov(F, i) = 0 A B β 1.2 0.8 E(r) 0.1 0.08 (1) What is the rate of return of the risk-free asset? (2) What is the expected rate of return of the well-diversified portfolio C with βC = 1.6, which also exists in the market? (3) A fund constructs a well-diversified portfolio D. Studies show that βD = 0.6. The expected rate of return of D is 0.06. Is there an arbitrage opportunity? If so, construct a trading strategy to earn profits with no risk. If not, why?arrow_forward
- The optimal proportion of the risky asset in the complete portfolio is given by the equation below y*= E(Rp− Rf) A0² For each of the variables on the right side of the equation, discuss the impact of the variable's effect on y* and why the nature of the relationship makes sense intuitively. Assume the investor is risk aversearrow_forwardwhich one is correct? QUESTION 6 Given a portfolio of stocks, the envelope curve containing the set of best possible combinations is known as the a. efficient frontier. b. utility curve. c. last frontier. d. efficient portfolio. e. capital asset pricing model.arrow_forwardchoose which one ? 3.Assume CAPM holds. What is the correlation between an efficient portfolio and the market portfolio?a.1b.-1c.0d.Not enough informationarrow_forward
- 3. The market has three assets. In addition, PAB = 0. F A B 0.2 0.3 1 3 E(r) 0.1 0 0 (a) If the investor can invest in the risk-free asset and one of the risky assets (either A or B, but not both). Will she choose A or B to construct a portfolio with the risk-free asset? Why? (Hint: you can draw a graph to answer this question.)arrow_forwardQ.Why we can make money more than the risk-premium under the CAPM from this strategy (zero-cost HML portfolio), given the value effectarrow_forwardConsider the following financial market with two risky assets x and y as well as a risk-free asset f: E[r]. x (10%, 8%) •z (6.6%, 6.3%) y (8%, 5%) (0%, 3%) f Is it possible to construct portfolio z with existing assets? Explain.arrow_forward
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