Case # 1- Risk & Return Question

1: Assume that after completion of your MBA you have started working as a financial planner at Askari Capital Limited. In a second week of Job you have got assignment to invest Rupees 100,000 for a client. Because the funds are to be invested in a business at the end of 1 year, you have been instructed to plan for a 1-year holding period. Moreover, your manager has restricted you to the investment alternatives in the following table, shown with their probabilities and associated outcomes.

Estimated rate of returns
State of the	Probability	T-Bills	Nescom	Nawab	PK_Steel	Pak Market portfolio
Recession	0.1	3%	-14.25	12.25	1.75	-9.75
Below average	0.2	3%	-4.75	5.25	-8.25	-2.75
Average	0.4	3%	6.25	-0.5	0.25	3.75
Above average	0.2	3%	13.75	-2.5	19.25	11.25
Boom	0.1	3%	21.25	-10	11.75	17.75
Expected Returns
St. Deviation		0%
CV
Beta

Askari Capital staff has estimated the probability values for the state of the economy, and also estimated the corresponding rate of return on each alternative under each state of the economy. Nescom. is technology firm, Nawab collects past-due debts, and PK_Steel manufactures steel products. Askari capital also maintains a market portfolio that owns a market-weighted fraction of all publicly traded stocks on Pakistan exchange market; you can invest in that portfolio and thus obtain average stock market results.

Given the situation described, answer the following questions:

1. Why is the T-bills return independent of the state of the economy? Do T-bills promise a completely risk-free return? Explain?

2. Why are Nescom returns expected to move with the economy, whereas Nawabs are expected to move counter to the economy?

3. Calculate the expected rate of return on each alternative.

4. You should recognize that basing a decision solely on expected returns is appropriate only for risk neutral individuals. Your client is risk-averse, the riskiness of each alternative is an important aspect of the decision. One possible measure of risk is the standard deviation of returns. Calculate this value for each alternative.

5. What type of risk is measured by the standard deviation?

6. Suppose you suddenly remembered that the coefficient of variation (CV) is generally regarded as being a better measure of stand-alone risk than the standard deviation when the alternatives being considered have widely differing expected returns. Calculate the CVs and interpret the results.

7. Suppose you created a two-stock portfolio by investing Rupees 50,000 in Nescom and Rupees 50,000 in Nawab. Now Calculate the expected return of portfolio, the standard deviation of portfolio and the coefficient of variation of portfolio. Also write about how the riskiness of this two-stock portfolio compares with the riskiness of the individual stocks if they were held in isolation?