Scenario

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.

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
		Fill in	Fill in	Fill in	Fill in	Fill in	Fill in
Mean
Standard		Fill in	Fill in	Fill in	Fill in	Fill in	Fill in
Deviation
Coefficient of Variation				7.9	1.4	1.0
Beta		0.00	1.10	-0.50	0.68	1.0

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.

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?