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essentials managerial finance

Questions and Answers of Essentials Managerial Finance

=+d. How would you characterize the correlations of returns of the two assets making up each of the two portfolios identified in part c?
=+e. What is the standard deviation for each portfolio?
=+f. Which portfolio do you recommend? Why?
=+LG 5 LG 6 ST8–2 Beta and CAPM Currently under consideration is an investment with a beta,b, of 1.50. At this time, the risk-free rate of return, RF, is 3%, and the return on the market portfolio
=+a. If the return on the market portfolio were to increase by 10%, what would you expect to happen to the investment’s return? What if the market return were to decline by 10%?
=+b. Use the capital asset pricing model (CAPM) to find the required return on this investment.
=+c. On the basis of your calculation in partb, would you recommend this investment? Why or why not?
=+d. Assume that as a result of investors becoming less risk averse, the market return drops by 3% to 8%. What effect would this change have on your responses in parts b and c?
=+LG 2 E8–3 The expected annual returns are 15% for investment 1 and 12% for investment 2.The standard deviation of the first investment’s return is 10%; the second investment’s return has a
=+E8–4 Suppose your portfolio has three asset classes. The U.S. government T-bills account for 25% of the portfolio, large-company stocks constitute 50%, and small-company stocks make up the
=+LG 5 E8–5 You wish to calculate the risk level of your portfolio based on its beta. The five stocks in the portfolio with their respective weights and betas are shown in the accompanying table.
=+E8–6a. Calculate the required rate of return for an asset that has a beta of 1.8, given a risk-free rate of 5% and a market return of 10%.
=+b. If investors have become more risk averse due to recent geopolitical events and the market return rises to 13%, what is the required rate of return for the same asset?
=+c. Use your findings in part a to graph the initial security market line (SML), and then use your findings in part b to graph (on the same set of axes) the shift in the SML.
=+P8–1 Rate of return A financial analyst for Smart Securities Limited, Paul Chan wishes to estimate the rate of return for two similar-risk investments, A and B. Paul’s research indicates that
=+a. Calculate the expected rate of return on investments A and B using the most recent year’s data.
=+b. Assuming the two investments are equally risky, which one should Paul recommend? Why?
=+LG 1 P8–2 Return calculations For each of the investments shown in the following table, calculate the rate of return earned over the period
=+P8–3 Risk preferences Stephen So, the financial manager for Cathay Pacific Incorporation, wishes to evaluate three prospective investments: A, B, and C. Stephen will evaluate each of these
=+a. If Stephen were risk neutral, which investments would he select? Explain why.
=+b. If he were risk averse, which investments would he select? Why?
=+c. If he were risk seeking, which investments would he select? Why?
=+d. Given the traditional risk preference behavior exhibited by financial managers, which investment would be preferred? Why?
=+LG 2 P8–4 Risk analysis Space Software is considering an investment in a new software that detects malware threats in the financial industry. Two possible types of expansion are under review.
=+a. Determine the range of rates of return for each of the two projects.
=+b. Which project seems less risky? Why?
=+c. If you were making the investment decision, which one would you chose? Why?
=+d. Assume that project B’s most likely outcome is 21% per year and that all other facts remain the same. Does your answer to part c now change? Why?
=+P8–5 Risk and probability Micro-Pub Inc. is considering the purchase of one of two microfilm cameras, R and S. Both should provide benefits over a 10-year period, and each requires an initial
=+a. Determine the range for the rate of return for each of the two cameras.
=+b. Determine the average return for each camera.
=+c. The purchase of which camera is riskier? Why?
=+P8–6 Bar charts and risk Swan’s Sportswear is thinking about bringing out a line of designer jeans. Currently, it is negotiating with two well-known designers. Because of the highly competitive
=+a. Construct a bar chart for each line’s annual rate of return.
=+b. Calculate the average return for each line.
=+c. Evaluate the relative riskiness for each jeans line’s rate of return using the bar charts.
=+LG 2 P8–7 Coefficient of variation Valley Forgings has identified four alternatives to meet its requirement for an additional production facility. The following table summarizes data gathered
=+a. Calculate the coefficient of variation for each alternative.
=+b. If the firm wishes to minimize risk, which alternative would you recommend? Why?
=+LG 2 P8–8 Standard deviation versus coefficient of variation as measures of risk Greengage Inc., a successful nursery, is considering several expansion projects. All the alternatives promise to
=+a. Which project is least risky, judging on the basis of range?
=+b. Which project has the lowest standard deviation? Explain why standard deviation may not be an entirely appropriate measure of risk for purposes of this comparison.
=+c. Calculate the coefficient of variation for each project. Which project do you think Greengage’s owners should choose? Explain why.Personal Finance Problem
=+LG 1 LG 2 P8–9 Rate of return, standard deviation, and coefficient of variation Mike is searching for a stock to include in his current stock portfolio. He is interested in Hi-Tech Inc.;he has
=+a. Calculate the rate of return for each year, 2015 through 2018, for Hi-Tech stock.
=+b. Calculate the average return over this time period.
=+c. Calculate the standard deviation of returns over the past 4 years.
=+d. Based on parts b andc, determine the coefficient of variation of returns for the security.
=+e. Given the calculation in partd, what should be Mike’s decision regarding the inclusion of Hi-Tech stock in his portfolio?
=+P8–10 Assessing return and risk Dacia Gears Ltd. has two alternative projects to choose from for their new distribution facility in Europe. The annual rate of return and the related probabilities
=+a. For each project, compute:(1) The range of possible rates of return.(2) The average return.(3) The standard deviation of the returns.(4) The coefficient of variation of the returns.
=+b. Construct a bar chart of each distribution of rates of return.
=+c. Which project would you consider more risky? Why?
=+LG 2 P8–11 Integrative: Expected return, standard deviation, and coefficient of variation Three assets—F, G, and H—are currently under consideration by Perth Industries. The probability
=+a. Calculate the average return, r, for each of the three assets. Which provides the largest average return?
=+b. Calculate the standard deviation, sr, for each asset’s returns. Which appears to have the greatest risk?
=+c. Calculate the coefficient of variation, CV, for each asset’s returns. Which appears to have the greatest relative risk?
=+P8–12 Normal probability distribution Answer the following questions, assuming that the rates of return associated with a given asset investment are normally distributed; that the expected
=+a. Find the standard deviation of returns, s.
=+b. Calculate the range of expected return outcomes associated with the following probabilities of occurrence: (1) 68%, (2) 95%, (3) 99%.
=+c. Draw the probability distribution associated with your findings in parts a and b.Personal Finance Problem
=+LG 3 P8–13 Portfolio return and standard deviation Jamie Wong is thinking of building an investment portfolio containing two stocks, L and M. Stock L will represent 40%of the dollar value of the
=+a. Calculate the actual portfolio return, rp, for each of the 6 years.
=+b. Calculate the average return for each stock and for the portfolio over the 6-year period.
=+c. Calculate the standard deviation of returns for each asset and for the portfolio.
=+How does the portfolio standard deviation compare to the standard deviations of the individual assets?
=+d. How would you characterize the correlation of returns of the two stocks L and M?
=+e. Discuss any benefits of diversification achieved by Jamie through creation of the portfolio.
=+LG 3 P8–14 Portfolio analysis You have been given the historical return data shown in the first table on three assets—F, G, and H—over the period 2016–2019.
=+Using these assets, you have isolated the three investment alternatives shown in the following table.Alternative Investment 1 100% of asset F 2 50% of asset F and 50% of asset G 3 50% of asset F
=+a. Calculate the average return over the 4-year period for each of the three alternatives.
=+b. Calculate the standard deviation of returns over the 4-year period for each of the three alternatives.
=+c. Use your findings in parts a and b to calculate the coefficient of variation for each of the three alternatives.
=+d. On the basis of your findings, which of the three investment alternatives do you think performed better over this period? Why?
=+LG 4 P8–15 Correlation, risk, and return Nikki Williams wishes to evaluate the risk and return behaviors associated with various combinations of assets X and Y under three assumed degrees of
=+a. If the returns of assets X and Y are perfectly positively correlated (correlation coefficient = +1), describe the range of (1) expected return and (2) risk associated with all possible
=+b. If the returns of assets X and Y are uncorrelated (correlation coefficient = 0), describe the approximate range of (1) expected return and (2) risk associated with all possible portfolio
=+c. If the returns of assets X and Y are perfectly negatively correlated (correlation coefficient = -1), describe the range of (1) expected return and (2) risk associated with all possible
=+LG 1 LG 4 P8–16 International investment returns Joe Martinez, a U.S. citizen living in Brownsville, Texas, invested in the common stock of Telmex, a Mexican corporation. He purchased 1,000
=+a. What was Joe’s investment return (in percentage terms) for the year, on the basis of the peso value of the shares?
=+b. The exchange rate for pesos was 9.21 pesos per US$1.00 at the time of the purchase. At the time of the sale, the exchange rate was 9.85 pesos per US$1.00.Translate the purchase and sale prices
=+c. Calculate Joe’s investment return on the basis of the US$ value of the shares.
=+d. Explain why the two returns are different. Which one is more important to Joe? Why?
=+LG 5 P8–17 Total, nondiversifiable, and diversifiable risk David Talbot randomly selected securities from all those listed on the New York Stock Exchange for his portfolio. He began with a
=+a. Plot the data from the table above on a graph that has the number of securities on the x-axis and the portfolio standard deviation on the y-axis.
=+b. Divide the total portfolio risk in the graph into its nondiversifiable and diversifiable risk components, and label each of these on the graph.
=+c. Describe which of the two risk components is the relevant risk, and explain why it is relevant. How much of this risk exists in David Talbot’s portfolio?
=+LG 5 P8–18 Graphical derivation of beta A firm wishes to estimate graphically the betas for two assets, A and B. It has gathered the return data shown in the following table for the market
=+a. On a set of “market return (x-axis)–asset return (y-axis)” axes, use the data given to draw the characteristic line for asset A and for asset B.
=+b. Use the characteristic lines from part a to estimate the betas for assets A and B.
=+c. Use the betas found in part b to comment on the relative risks of assets A and B.
=+P8–19 Graphical derivation and interpreting beta You are analyzing the performance of two stocks. The first, shown in Panel A, is Cyclical Industries Incorporated. Cyclical Industries makes
=+a. Which stock do you think has a higher standard deviation? Why?
=+b. Which stock do you think has a higher beta? Why?
=+c. Which stock do you think is riskier? What does the answer to this question depend on?
=+LG 5 P8–20 Interpreting beta Schembri Investment Company Ltd. wishes to assess the impact of changes in the market return on an asset that has a beta of 0.80.
=+a. If the market return increased by 42%, what impact would this change be expected to have on the asset’s return?
=+b. If the market return decreased by 32%, what impact would this change be expected to have on the asset’s return?
=+c. If the market return did not change, what impact, if any, would be expected on the asset’s return?
=+d. Would this asset be considered more or less risky than the market? Explain.

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