Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Returns on Alternative Investments (Estimated Rate of Return) State of the Economy Probability T-Bills Phillips Pay-up Rubber-made Market Portfolio 2-Stock Portfolio Recession 0.2 7.0 -22.0

Returns on Alternative Investments

(Estimated Rate of Return)

State of the Economy

Probability

T-Bills

Phillips

Pay-up

Rubber-made

Market Portfolio

2-Stock Portfolio

Recession

0.2

7.0

-22.0

28.0

10.0

-13.0

3.0

Below Average

0.1

7.0

-2.0

14.7

-10.0

1.0

0.0

Average

0.3

7.0

20.0

0

7.0

15.0

10.0

Above Average

0.3

7.0

35.0

-10.0

45.0

29.0

0.0

Boom

0.1

7.0

50.0

-20.0

30.0

43.0

15.0

Mean

Fill in

Fill in

Fill in

Fill in

Fill in

Fill in

Standard

Deviation

Fill in

Fill in

Fill in

Fill in

Fill in

Fill in

Coefficient of Variation

7.9 1.4

1.0

Beta

0.00

1.10

-0.50

0.68

1.0

As a finance major student of the UWI OC, you have just landed a lucrative job as a Financial Planner with First Citizens Investment Services (FCIS), a major financial services company in your home country. Your first assignment is to invest $100,000 for a reputable client of the firm. The funds are to be invested in a business at the end of one year, and you have been instructed to plan for a one-year holding period. You have been restricted by the CEO to the following investment alternatives, shown with their probabilities and associated outcomes.

Analysts at the firm have developed probability estimates for the state of the economy, and its security manager has developed a sophisticated computer program which was used to estimate the rate of return of each alternative under each state of the economy. Phillips Corp. is an electronics firm, Pay-up Ltd. is a debt collection agency, and Rubber-made Corp produces plastic products and household goods. FCIS maintains an index fund which owns a market-weighted fraction of all publicly traded stocks; you can invest in that fund, and obtain average stock market results. Based on the aforementioned scenario, answer the following questions.

1. What is the T-Bill rate composed of? Are T-Bills completely risk-free?

2. Why are Phillips returns expected to move with the economy whereas Pay-ups are expected to move counter to the economy?

3. Calculate the expected rate of return on each alternative and fill in the blanks on the Row for Mean in the table above.

4. Your client is risk averse and the riskiness of each alternative is important in your decision. Calculate the standard deviation for each alternative, and fill in the row in the table above.

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

6. You created a two stock portfolio by investing $50,000 in Phillips and $50,000 in Pay-up.

a. Calculate the expected return, standard deviation and the coefficient of variation for this portfolio and enter in the appropriate blanks in the table above.

b. How does the riskiness of this 2-stock portfolio compare to the riskiness of the individual stocks if they were held in isolation?

7. Use the security market line equation to calculate the required rate of return on each alternative.

a. How do the expected rates of return compare with the required rate of return? (State whether they were fairly valued, overvalued, undervalued)

b. Which of the stocks would you recommend purchasing and why?

c. What would be the market risk and the required return of a 50-50 portfolio of Phillips and Pay-up AND of Phillips and Rubber-made?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Financial Markets And Institutions

Authors: Frederic S. Mishkin, Stanley Eakins

6th International Edition

0321552113, 9780321552112

More Books

Students also viewed these Finance questions

Question

3. Are psychopaths anxious?

Answered: 1 week ago

Question

TONA A ALL 19 WOMATION NORMATION TONA A ALL 19 WOMATION NORMATION

Answered: 1 week ago

Question

Define and discuss the nature of communication

Answered: 1 week ago

Question

Define and discuss the nature of culture

Answered: 1 week ago