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Shane Miller Peachtree Securities, Inc. (A) Q1 Q2 Q3 Q4 Q3 Q5 Q6 A.) What would the portfolio's expected rate of return, standard deviation, and coefficient of variation be? How does this compare with the individual stocks? Now Consider a portfolio consisting of $10,000 in TECO and $10,000 in the S&P 500 Fund. Would this portfolio have the same risk reducing effects as the Goldhill-TECO portfolio? Suppose an investor starts with a portfolio consisting of one stock. What do you think would happen if more randomly selected stocks were added? The T-bond return in table one is shown to be independent of the state of the economy because, once purchased, bonds pay out equal returns no matter what the state of the economy is. The return on a one year treasury bond is basically risk free. The United States Treasury would have to go bankrupt within a year for the bond to not be paid and the odds of that happening are extremely low. Equations • Standard deviation measures historical volatility
• Coefficient of variation also measures volatility
in a stock but it is in comparison to the amount of
return you can expect on an investment instead of
• Coefficient of Variation is the better measurement Q7 Now change Table 1 by crossing out the state of the economy and probability columns and replacing them with year 1 through 5. Then, plot three lines on a scatter diagram which shows the returns on the S&P 500 (the market). What are these lines called? Estimate the the slope coefficient of each line. What is the slope coefficient called, and what is the significance? What is the significance of the distance between the plot points and the regression line? Q8 Plot the security market line. What is the required rate of return on TECO's stock using Value Line's beta estimate of 0.6 as reported in Figure 1? Based on the CAPM analysis, should investors buy TECO stock? Q9 Q10 Efficient markets hypothesis states that it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.
Collects valuable information
Should be considered when adding to his staff of
security analysts Increasing inflation causes the required rate of return to increase to 13.40%
Increasing the the market risk premium to to 8% causes the required rate of return to be 12.80%
If beta were to rise from 0.6 to 1.0, then TECO's required rate of return would be 15.0% The Company:
Brokerage Firm Based In Atlanta
Prosperous In The Past
Starting To Run Into Problems The Problem:
Transactions Per Customer Decreasing
Mutual Funds At The Heart Of The Problem
Product Line Needs To Be Expanded
Rising Cost Of Subscription Services The Solution:
In House Analyst For Electric Industry
Conducting A Seminar On Stock Investments
Pick 1 Electric Utility
Compute Required Rate Of Return
Present Findings B.) What do you think would happen to the portfolio's expected rate of return and standard deviation if the portfolio contained 75 percent Gold Hill? If it Contained 75 Percent TECO? The three lines on the graph are called historical percentages based on market returns. Slope coeffeicient is your Beta. The significance of Beta is that it allows you to get a better grasp on the extent on which the returns of a given stock move with the market. A regression line will always contain error terms due to the independent variables that are never perfect predictions of dependent variables. the regression line will never include all possible variables. The 13.5% expected return is higher then the 12.2% required rate so therefore you should purchase TECO stock. 9.) What would happen to TECO's required rate of return if inflation expectations increased by 3 percentage points above the estimated embedded in the 8 percent risk-free rate? Now go back to the original inflation estimate, where kRF= 8%, and indicate what would happen to TECO's required rate of return if the investors' risk aversion increased so that the market risk premium rose from 7 percent to 8 percent. Now go back to the original conditions (kRF= 8%, RPm= 7%) and assume that TECO's beta rose from 0.6 to 1.0. What effect would this have on the required rate of return? What is the efficient markets hypothesis (EMH)? What impact does this theory have on decisions concerning the investment in securities? It is applicable to real assets such as plant and equipment? What impact does the EMH have on corporate financing decisions? Should Jake Taylor be concerned about the EMH when he considers adding to his staff of security analysts? Explain Questions? Suppose an investor forms a stock portfolio by investing $10,000 in Goldhill and $10,000 in TECO . What characteristic of the two investments makes risk reduction possible? Calculate the expected returns and standard deviation for a portfolio of mix of 0 percent TECO- 100 percent TECO NO If a portfolio that consisted of one random stock had more and more randomly selected stocks added, there would be two factors that could change the portfolio’s risk. The risk of the portfolio would increase if the security was more risky and decrease if it was less risky. This would happen assuming that the incoming stocks are positively correlated with the existing one. If they are negatively correlating depending on weights, the high risks will offset each other, actually producing less risk. What are the implications for investors? Do portfolio effects impact the way investors should think about the riskiness of individual securities? Would you expect this to effect companies' cost of capital? Investor implications revolve around how the securities within their portfolio would react to stimulus within the market, whether the same or different reaction. Portfolio effects absolutely impact the way investors associate the risk of an individual security, because some risky investments seem more attractive when associated with securities that are negatively correlation, meaning they react differently to stimuli within the market. It may affect the a company’s cost of capital only if dividends are issued. Once an IPO is issued, the stock does not add value to the actual financing. The differences between total risk, company specific risk, and market risk Company specific, or diversifiable risk, is a risk that a price change will occur due to unique circumstances to the company. It is often referred to as Un-systematic risk and can be eliminated through the diversification of a portfolio. Market risk, also known as systematic risk, is risk that is associated with the overall market specific securities and sometimes the entire market. It is affected by economic changes or other events that impact large portions of the market. Asset allocation can defend against this due to the fact the some segments under perform others at different times. The total risk is the culmination of both systematic and un-systematic involved with the collection of securities. Assume that you choose to hold a single stock portfolio. Should you expect to be compensated for all the risk that you bear? A large standard deviation shows that the stock is very risky. To expect that you will receive the required rate with a stock of high standard deviation is naïve due to the risk of no allocation. If the stock underperforms, your portfolio loses value. That isn't to say that you can benifit from this strategy, but it is a gamble. Why is the T-bond in table 1 shown to be independent of the state of the economy? Is the return on a 1-year T-bond risk free? Calculate the expected rate of return on each of the four alternatives listed in Table 1. Based solely on expected returns, which of the potential investments appears best Now calculate the standard deviations and coefficients of variation of returns for the four alternatives. What type of risk do these statistics measure? How do the alternatives compare when risk is considered?