A family friend of yours calls you up asking for financial advice. She works for Boing (a local aircraft manufacturer) and is offered, as an employee benefit, an opportunity to spend $10,000 to buy company stocks once a year at a 10% discount (employee stock plan). That is, if the stock price is $100/share, she can spend $10,000 and obtain 110 shares. This is a take it or leave it deal, and she will not be able to sell the stock for at least one year. Assume that she is an engineer who is not privy to any material inside information.

She understands the concept of diversification, and understands that her own job security depends on the well-being of the company. Her rough analysis of her future job prospects and her assets estimates 50% of her wealth (from her job) to be in Boing, and 50% in the US market. Assume that the value of her job at Boing is perfectly reflected by the Boing stock. (So her portfolio is essentially 50% Boing stock and 50% US market).

Assume also that, to her, $10,000 is fairly small.

The US market has an expected return of 14%, standard deviation of 15%. The risk-free rate is 4%. Boing stock has an expected return of 12%, standard deviation of 25%. The correlation between Boing stock and the US market is 80%.

Calculate the following and show your computations.

a) Expected return on her current portfolio (including the value of her job): b) Sharpe Ratio of her current portfolio:

c) If the US market portfolio is MVE, what should be the expected return of Boing stock?

d) If the US market portfolio is MVE, what is the highest expected return that any portfolio can achieve, if that portfolio has a standard deviation of 9%?

e) Assume that the expected return of Boing stock is 12%. Should she participate in the employee stock plan (at 10% discount)?

Hint: you can treat the discount as an added return on holding the stock.