47 c. Construct a scatter diagram graph that shows Goodman's and Landry' returns on the vertical axis and 48 the Market Index's returns on the horizontal axis. 49 50 It is easiest to make scatter diagrams with a data set that has the X-axis variable in the left column, 51 so we reformat the returns data calculated above and show it just below. 52 53 Year Index Goodman Landry 54 2018 32.8% 24.8% -1.1% 55 2017 1.2% -4.2% 13.2% 56 2016 34.9% 62.7% -10.0% 57 2015 14.9% 2.9% -0.4% 2014 19.1% 60.9% 11.7% 59 60 61 58 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 To make the graph, we first selected the range with the returns and the column heads, then clicked the chart wizard, 77 then choose the scatter diagram without connected lines. That gave us the data points. We then used the drawing 78 toolbar to make free-hand ("by eye") regression lines, and changed the lines color and weights to match the dots. 79 80 It is clear that Goodman moves with the market and Landry moves counter to the market. So, Goodman has a positive 81 beta and Landry a negative one. 82 d. Estimate Goodman's and Landry's betas as the slopes of regression lines with stock returns on the vertical axis (y-axis) and market return on the horizontal axis (x-axis). (Hint: use Excel's SLOPE function.) Are these betas consistent with your graph? Goodman's beta = Landry' beta = e. The risk-free rate on long-term Treasury bonds is 6.04%. Assume that the market risk premium is 5%. What is the expected return on the market? Now use the SML equation to calculate the two companies' required returns. Market risk premium (RPM) = Risk-free rate = 5.000% 6.040% 1 Expected return on market = + Risk-free rate 6.040% 11.040% Market risk premium 5.000% + 7 5 Required return - Goodman: B Required return Landry: 2 Required return 8 9 f. If you formed a portfolio that consisted of 50% Goodman stock and 50% Landry stock, what would be its O beta and its required return? 1 2 The beta of a portfolio is simply a weighted average of the betas of the stocks in the portfolio, so this portfolio's beta 3 would be: 4 5 Portfolio beta = 6 7 g. Suppose an investor wants to include Goodman Industries' stock in his or her portfolio. Stocks A, B, and C are currently in the portfolio, and their betas are 0.769, 0.985, and 1.423, respectively. Calculate the 9 new portfolio's required return if it consists of 25% of Goodman, 15% of Stock A, 40% of Stock B, and 20% 0 of Stock C. 1 2 3 Beta Portfolio Weight 4 Goodman 25% 5 Stock A 0.769 15% 6 Stock B 0.985 40% 7 Stock C 1.423 20% 8 100% 9 Portfolio Beta = 0 1 Required return on portfolio: Risk-free rate + Market Risk Premium Beta 2 3 4