please answer correctly and show workings

Assume that you recently graduated and landed a job as a financial planner with Cicero Services, an investment advisory company. Your first client recently inherited some assets and has asked you to evaluate them. The client owns a bond portfolio with $1 million invested in zero coupon Treasury bonds that mature in 10 years. 47 The client also has $2 million invested in the stock of Blandy, Inc., a company that produces meat-and-potatoes frozen dinners. Blandy's slogan is "Solid food for shaky times." Unfortunately, Congress and the president are engaged in an acrimonious dispute over the budget and the debt ceiling. The outcome of the dispute, which will not be resolved until the end of the year, will have a big impact on interest rates 1 year from now. Your first task is to determine the risk of the client's bond portfolio. After consulting with the economists at your firm, you have specified five possible scenarios for the resolution of the dispute at the end of the year. For each scenario, you have estimated the probability of the scenario occurring and the impact on interest rates and bond prices if the scenario occurs. Given this information, you have calculated the rate of return on 10-year zero coupon Treasury bonds for each scenario. The probabilities and returns are shown here: You have also gathered historical returns for the past 10 years for Blandy, Gourmange Corporation (a producer of gourmet specialty foods), and the stock market. c. Use the scenario data to calculate the expected rate of return for the 10 -year zero coupon Treasury bonds during the next year. d. What is stand-alone risk? Use the scenario data to calculate the standard deviation of the bond's return for the next year. e. Your client has decided that the risk of the bond portfolio is acceptable and wishes to leave it as it is. Now your dient has asked you to use historical returns to estimate the Reserved. May not be copied, seanned, or dephcatod, in uhole or in part. Due to clactronic rights some third party coetent muy be suppressed from the efook and or ochap? atent does pot maberially affect the overall leaming experience. Cengage learning reserves the right a remove additional cantent at any time if absequeat nghts reririctions Chapter 6 Risk and Return 291 standard deviation of Blandy's stock returns. (Note: Many analysts use 4-5 years of monthly returns to estimate risk and many use 52 weeks of weekly returns; some even use a year or less of daily returns. For the sake of simplicity, use Blandy's 10 annual returns.) f. Your client is shocked at how much risk Blandy stock has and would like to reduce the level of risk. You suggest that the client sell 25% of the Blandy stock and create a portfolio with 75% Blandy stock and 25% in the high-risk Gourmange stock. How do you suppose the client will react to replacing some of the Blandy stock with high-risk stock? Show the client what the proposed portfolio return would have been in each year of the sample. Then calculate the average return and standard deviation using the portfolio's annual returns. How does the risk of this two-stock portfolio compare with the risk of the individual stocks if they were held in isolation? g. Explain correlation to your client. Calculate the estimated correlation between Blandy and Gourmange. Does this explain why the portfolio standard deviation was less than Blandy's standard deviation? j. According to the Capital Asset Pricing Model, what measures the amount of risk that an individual stock contributes to a well-diversified portfolio? Define this measurement. 1. Calculate the correlation coefficient between Blandy and the market. Use this and the previously calculated (or given) standard deviations of Blandy and the market to estimate Blandy's beta. Does Blandy contribute more or less risk to a well-diversified portfolio than does the average stock? Use the SML to estimate Blandy's required return. n. (1) Suppose the risk-free rate goes up to 7%. What effect would higher interest rates have on the SML and on the returns required on high-risk and low-risk securities? (2) Suppose instead that investors' risk aversion increased enough to cause the market risk premium to increase to 8%. (Assume the risk-free rate remains constant.) What effect would this have on the SML and on returns of high- and lowrisk securities? Assume that you recently graduated and landed a job as a financial planner with Cicero Services, an investment advisory company. Your first client recently inherited some assets and has asked you to evaluate them. The client owns a bond portfolio with $1 million invested in zero coupon Treasury bonds that mature in 10 years. 47 The client also has $2 million invested in the stock of Blandy, Inc., a company that produces meat-and-potatoes frozen dinners. Blandy's slogan is "Solid food for shaky times." Unfortunately, Congress and the president are engaged in an acrimonious dispute over the budget and the debt ceiling. The outcome of the dispute, which will not be resolved until the end of the year, will have a big impact on interest rates 1 year from now. Your first task is to determine the risk of the client's bond portfolio. After consulting with the economists at your firm, you have specified five possible scenarios for the resolution of the dispute at the end of the year. For each scenario, you have estimated the probability of the scenario occurring and the impact on interest rates and bond prices if the scenario occurs. Given this information, you have calculated the rate of return on 10-year zero coupon Treasury bonds for each scenario. The probabilities and returns are shown here: You have also gathered historical returns for the past 10 years for Blandy, Gourmange Corporation (a producer of gourmet specialty foods), and the stock market. c. Use the scenario data to calculate the expected rate of return for the 10 -year zero coupon Treasury bonds during the next year. d. What is stand-alone risk? Use the scenario data to calculate the standard deviation of the bond's return for the next year. e. Your client has decided that the risk of the bond portfolio is acceptable and wishes to leave it as it is. Now your dient has asked you to use historical returns to estimate the Reserved. May not be copied, seanned, or dephcatod, in uhole or in part. Due to clactronic rights some third party coetent muy be suppressed from the efook and or ochap? atent does pot maberially affect the overall leaming experience. Cengage learning reserves the right a remove additional cantent at any time if absequeat nghts reririctions Chapter 6 Risk and Return 291 standard deviation of Blandy's stock returns. (Note: Many analysts use 4-5 years of monthly returns to estimate risk and many use 52 weeks of weekly returns; some even use a year or less of daily returns. For the sake of simplicity, use Blandy's 10 annual returns.) f. Your client is shocked at how much risk Blandy stock has and would like to reduce the level of risk. You suggest that the client sell 25% of the Blandy stock and create a portfolio with 75% Blandy stock and 25% in the high-risk Gourmange stock. How do you suppose the client will react to replacing some of the Blandy stock with high-risk stock? Show the client what the proposed portfolio return would have been in each year of the sample. Then calculate the average return and standard deviation using the portfolio's annual returns. How does the risk of this two-stock portfolio compare with the risk of the individual stocks if they were held in isolation? g. Explain correlation to your client. Calculate the estimated correlation between Blandy and Gourmange. Does this explain why the portfolio standard deviation was less than Blandy's standard deviation? j. According to the Capital Asset Pricing Model, what measures the amount of risk that an individual stock contributes to a well-diversified portfolio? Define this measurement. 1. Calculate the correlation coefficient between Blandy and the market. Use this and the previously calculated (or given) standard deviations of Blandy and the market to estimate Blandy's beta. Does Blandy contribute more or less risk to a well-diversified portfolio than does the average stock? Use the SML to estimate Blandy's required return. n. (1) Suppose the risk-free rate goes up to 7%. What effect would higher interest rates have on the SML and on the returns required on high-risk and low-risk securities? (2) Suppose instead that investors' risk aversion increased enough to cause the market risk premium to increase to 8%. (Assume the risk-free rate remains constant.) What effect would this have on the SML and on returns of high- and lowrisk securities