Chapter 2: Q19I (page 185)
A project has a .7 chance of doubling your investment in a year and a .3 chance of halving your investment in a year. What is the standard deviation of the rate of return on this investment?
68.74%
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Joan McKay is a portfolio manager for a bank trust department. McKay meets with two clients, Kevin Murray and Lisa York, to review their investment objectives. Each client expresses an interest in changing his or her individual investment objectives. Both clients currently hold well-diversified portfolios of risky assets.
a. Murray wants to increase the expected return of his portfolio. State what action McKay should take to achieve Murray’s objective. Justify your response in the context of the capital market line.
b. York wants to reduce the risk exposure of her portfolio but does not want to engage in borrowing or lending activities to do so. State what action McKay should take to achieve York’s objective. Justify your response in the context of the security market line.
When adding a risky asset to a portfolio of many risky assets, which property of the asset is more important, its standard deviation or its covariance with the other assets? Explain.
The APT itself does not provide information on the factors that one might expect to determine risk premiums. How should researchers decide which factors to investigate?
Is industrial production a reasonable factor to test for a risk premium? Why or why not?
XYZ stock price and dividend history are as follows:
Year Beginning-of-Year Price Dividend Paid at Year-End
2010 \(100 \)4
2011 \(110 \)4
2012 \( 90 \)4
2013 \( 95 \)4
An investor buys three shares of XYZ at the beginning of 2010, buys another two shares at the beginning of 2011, sells one share at the beginning of 2012, and sells all four remaining shares at the beginning of 2013.
a. What are the arithmetic and geometric average time-weighted rates of return for the investor?
b. What is the dollar-weighted rate of return?
(Hint: Carefully prepare a chart of cash flows for the four dates corresponding to the turns of the year for January 1, 2010, to January 1, 2013. If your calculator cannot calculate internal rate of return, you will have to use a spreadsheet or trial and error.).
Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 4% and IR 6%. A stock with a beta of 1 on IP and .4 on IR currently is expected to provide a rate of return of 14%. If industrial production actually grows by 5%, while the inflation rate turns out to be 7%, what is your best guess for the rate of return on the stock?
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