Investment Analysis - Problem Set 10

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is the market risk premium calculated in the content?

11.5%

20.30%

4.5%

7% (correct)

Which company's required return was calculated using the CAPM to be 23.9%?

Southwest Airlines

Eastman Kodak

Praxair (correct)

US Bancorp

What is the portfolio beta calculated in the content?

1.833 (correct)

2.9

0.7

1.5

Which required return model provided a higher estimate for US Bancorp?

CAPM Signup and view all the answers

What is the risk premium for Southwest Airlines calculated using its beta?

4.9% Signup and view all the answers

Can a market be semi-strong-form efficient but not weak-form efficient?

No, weak-form efficiency is a requirement for semi-strong-form efficiency. Signup and view all the answers

If the market usually overreacts to bad news, what is a potential strategy for making a profit?

Buying stocks after bad news to benefit from price recovery. Signup and view all the answers

Why is the shareholders' required return important for corporate managers?

It indicates the minimum return needed to meet capital costs. Signup and view all the answers

What is the required return if the risk-free rate is 3 percent and the risk premium is 5 percent?

8 percent Signup and view all the answers

What is Hastings' required return if it has a beta of 0.65, the market return is expected at 11 percent, and the risk-free rate is 4 percent?

8.55 percent Signup and view all the answers

If you have a portfolio with a beta of 1.35, what will the new portfolio beta be if you invest 85 percent in it and 15 percent in a stock with a beta of 0.78?

1.26 Signup and view all the answers

What happens to the required return if the risk-free rate decreases while holding the risk premium constant?

The required return will decrease. Signup and view all the answers

Which statement about market efficiency is accurate?

Semi-strong-form efficiency incorporates all public information. Signup and view all the answers

What distinguishes average return from expected return?

Average return is calculated from historical data only, whereas expected return incorporates probabilities. Signup and view all the answers

Why do investors accept market risk when investing?

Investors expect to earn a risk premium, leading to greater wealth accumulation. Signup and view all the answers

What is the significance of portfolios on the capital market line compared to those on the efficient frontier?

Portfolios on the capital market line provide higher expected return for the same risk level. Signup and view all the answers

What is one reason a firm’s beta might be considered too low?

The firm operates in a competitive industry with constant market battles. Signup and view all the answers

Which method is used to measure both historical and expected risk?

Standard deviation Signup and view all the answers

Which firm mentioned seems to have an appropriate beta reflecting its market risk?

Procter & Gamble, because of its diversified product range. Signup and view all the answers

What type of average is used to compute average return?

Simple average Signup and view all the answers

What does a higher beta value indicate about a firm?

It is more sensitive to market movements and carries greater risk. Signup and view all the answers

What is Paccar's required return based on the projected dividend and growth rate?

10.46% Signup and view all the answers

What is the expected return from the given economic state probability distribution?

8.5% Signup and view all the answers

What is the portfolio beta of an investor with $10,000 in Olympic Steel, $7,000 in Rent-a-Center, and $8,000 in Lincoln Educational?

1.46 Signup and view all the answers

Which component is NOT involved in calculating the standard deviation of expected return?

Actual market return Signup and view all the answers

How do you calculate the weight of Olympic Steel in the portfolio?

$10,000 divided by $25,000 Signup and view all the answers

Which of the following values represents the risk-free rate mentioned in the problems?

4.5% Signup and view all the answers

What is the market risk premium if the market return is 11.5% and the risk-free rate is 4.5%?

7.0% Signup and view all the answers

What is the overall portfolio value calculated from the investments listed?

$25,000 Signup and view all the answers

Study Notes

Problem Set 10 - Study Notes

Problem 1 (a): Average return is calculated by averaging historical returns. Expected return is a forward-looking estimate, weighted by the probability of different outcomes. Both methods use historical data, though expected return is forward-looking. Historical risk and expected risk (both measured in standard deviation) use historical return data.
Problem 1 (b): People take investment risk to potentially earn a risk premium (more return than risk-free investment). This allows for significant wealth growth, but investors must have a long-term perspective and acknowledge potential short-term losses.
Problem 2 (a): Portfolios on the Capital Market Line (CML) provide better risk-return trade-offs because they offer higher returns at every risk level compared to the efficient frontier.
Problem 2 (b): Procter & Gamble and Johnson & Johnson have reasonable betas (0.38, 0.70), indicating appropriate risk for their firm types. Nike's (0.84) beta is potentially too low, hinting at lower risk than expected. Goldman Sachs' beta (1.50) is high, implying a relatively high level of risk compared to competitors like JPMorgan Chase (1.22).
Problem 3 (a): A market can be semi-strong-form efficient but not weak-form efficient. This is contradictory - a market cannot be semi-strong-form efficient without also being weak-form efficient because weak-form efficiency is essentially a subset of or part of the semi-strong-form.
Problem 3 (b): If the market overreacts to bad news, investors could profit by buying stocks after significant price drop due to bad news, and capitalizing on the rebound.
Problem 4: Shareholders' required return is important because managers must ensure the projects they fund (using shareholder resources) achieve a return that exceeds the required return. This is crucial to maintain investor confidence and secure future funding.
Problem 5: Required return = risk-free rate + risk premium (3% + 5% = 8%).
Problem 6: Hastings Entertainment's required return (using CAPM) is 8.55% (risk-free rate + beta * market risk premium).
Problem 7: The new portfolio's beta is found by weighting the old portfolio beta with the new stock beta. (0.85 multiplied by old portfolio Beta + 0.15 multiplied by new beta).
Problem 8: Paccar's required return is calculated by using the formula from slide 10-31 (use the formula from the provided slide).
Problem 9: Standard Deviation (calculate the standard deviation for the different returns given).
Problem 10: This problem involves calculating the portfolio beta. This requires calculating the weight of each stock in the portfolio and then using those weights to calculate the weighted average beta.
Problem 11: This problem also involves calculating portfolio beta. Again, find the weight of each stock in the portfolio, and then find the average.
Problem 12: Required return for each company is calculated using both CAPM and the constant-growth model. Results are then compared.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

This quiz covers advanced concepts in investment analysis, including the calculation of average and expected returns, risk premiums, and the Capital Market Line. It explores portfolio efficiency and risk measurements in financial markets. Prepare to test your understanding of these key topics and their implications for investing.