Question
The Sharpe case is a good opportunity for you to apply the stock and portfolio analysis metrics that we recently covered in class. Put yourself
The Sharpe case is a good opportunity for you to apply the stock and portfolio analysis metrics that we recently covered in class. Put yourself in the shoes of Alex Sharpe, who is moving from a passive investment strategy focused on the Vanguard 500 index fund to an active investment strategy by selecting a specific stock to add to her (small) portfolio.
In the questions below, you are asked to analyze returns for Hasbro and R.J. Reynolds Tobacco Company to determine which stock you should add to the portfolio. Please answer the following questions in your writeup:
1.Calculate and compare the annual returns and annual standard deviation on a stand-alone basis for the 5-year period for 1) the Vanguard 500 Fund, 2) Reynolds stock, and 3) Hasbro stock. Which stock appears to be riskier, Reynolds or Hasbro?
2.Of the total portfolio investment, suppose 99% of Sharpe's portfolio was invested in the Vanguard 500 Fund and the remaining 1% was invested in either Reynolds or Hasbro. Calculate the standard deviation of a Vanguard 500-Reynolds portfolio versus Vanguard 500-Hasbro portfolio and compare it to the Vanguard 500's stand-alone standard deviation. Compare this to what you found when you analyzed each of the companies in question 1.
3.Calculate beta for the monthly returns on 1) Reynolds, and 2) Hasbro per the monthly returns on the Vanguard 500. You can use Excel in just the same way as I demonstrated in class. What does the beta for each stock tell you about that stock compared to the Vanguard 500? In this case, the Vanguard 500 is acting as a benchmark for the market. Compare the beta results to what you found in question 2.
4.Use the Capital Asset Pricing Model (CAPM) to determine the required rate of return for Reynolds and Hasbro. For this question, use a risk-free rate of 2%, the average annual return for the Vanguard 500 fund as the market rate, and beta for Reynolds and Hasbro. Explain what the results mean for each stock.
5.Using your calculations from questions 1-5, make a recommendation as to whether Alex should invest 1% of her portfolio in either Reynolds or Hasbro given that she has just decided to move from a passive to active investing strategy and, according to the case, she "wanted to begin conservatively."
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