Investments Chapter 5

EAR

Effective Annual Return- Need to annualize rates to compare them

HPR

Holding Period Return

Standard Deviation Score

How many SD you are away from the historical average is a return

Real Return

Return relatable to inflation rate as measured by consumer price index- Real Return= nominal rate-inflation rate

Geometric Avg Return

investments avg return per year on average but takes compounding into consideration

Variance

uses historical to determine expected return

E(R)

weighted average of potential returns in various states of economy

Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $70,000 or $190,000, with equal probabilities of 0.5. The alternative riskless investment in T-bills pays 5%. a. If you require a risk premium of 7%, how much will you be willing to pay for the portfolio? (Round your answer to the nearest dollar amount.) Value of the portfolio $ b. Suppose the portfolio can be purchased for the amount you found in (a). What will the expected rate of return on the portfolio be? (Do not round intermediate calculations. Round your answer to the nearest whole percent.) Rate of return c.Now suppose you require a risk premium of 10%. What is the price you will be willing to pay now? (Round your answer to the nearest dollar amount.) Value of the portfolio $

116,071 12 correct % 113,043 correct

Assume that you manage a risky portfolio with an expected rate of return of 14% and a standard deviation of 38%. The T-bill rate is 5%. Your client chooses to invest 85% of a portfolio in your fund and 15% in a T-bill money market fund. a. What is the expected return and standard deviation of your client's portfolio? (Round your answers to 2 decimal places.) Expected return 12.65 correct % per year Standard deviation 32.30 correct % per year b. Suppose your risky portfolio includes the following investments in the given proportions: Stock A 22% Stock B 31% Stock C 47% What are the investment proportions of your client's overall portfolio, including the position in T-bills? (Round your answers to 2 decimal places.) Security Investment Proportions T-Bills 15.00 correct % Stock A 18.70 correct % Stock B 26.35 correct % Stock C 39.95 correct % c. What is the reward-to-volatility ratio (S) of your risky portfolio and your client's overall portfolio? (Round your answers to 4 decimal places.) Reward-to-Volatility Ratio Risky portfolio 0.0097 incorrect Client's overall portfolio 0.0121 incorrect

Assume that you manage a risky portfolio with an expected rate of return of 14% and a standard deviation of 38%. The T-bill rate is 5%. Your client chooses to invest 85% of a portfolio in your fund and 15% in a T-bill money market fund. a. What is the expected return and standard deviation of your client's portfolio? (Round your answers to 2 decimal places.) Expected return 12.65 correct % per year Standard deviation 32.30 correct % per year b. Suppose your risky portfolio includes the following investments in the given proportions: Stock A 22% Stock B 31% Stock C 47% What are the investment proportions of your client's overall portfolio, including the position in T-bills? (Round your answers to 2 decimal places.) Security Investment Proportions T-Bills 15.00 correct % Stock A 18.70 correct % Stock B 26.35 correct % Stock C 39.95 correct % c. What is the reward-to-volatility ratio (S) of your risky portfolio and your client's overall portfolio? (Round your answers to 4 decimal places.) Reward-to-Volatility Ratio Risky portfolio 0.0097 incorrect Client's overall portfolio 0.0121 incorrect

Arithmetic Average

Average return in an average year but ignores compounding

Suppose your expectations regarding the stock market are as follows: State of the Economy Probability HPR Boom 0.2 40% Normal growth 0.3 20 Recession 0.5 -17 Use above equations to compute the mean and standard deviation of the HPR on stocks. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Mean Standard deviation

Mean 5.50 correct % Standard deviation 23.54%

The stock of Business Adventures sells for $60 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows: Dividend Stock Price Boom $2.00 $70 Normal economy 1.80 63 Recession .90 54 a. Calculate the expected holding-period return and standard deviation of the holding-period return. All three scenarios are equally likely. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return 6.50 correct % Standard deviation 11.68 correct % b. Calculate the expected return and standard deviation of a portfolio invested half in Business Adventures and half in Treasury bills. The return on bills is 5%. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return 5.75 correct % Standard deviation 5.84 correct %

The stock of Business Adventures sells for $60 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows: Dividend Stock Price Boom $2.00 $70 Normal economy 1.80 63 Recession .90 54 a. Calculate the expected holding-period return and standard deviation of the holding-period return. All three scenarios are equally likely. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return 6.50 correct % Standard deviation 11.68 correct % b. Calculate the expected return and standard deviation of a portfolio invested half in Business Adventures and half in Treasury bills. The return on bills is 5%. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return 5.75 correct % Standard deviation 5.84 correct %

You manage an equity fund with an expected risk premium of 12.6% and a standard deviation of 40%. The rate on Treasury bills is 6.4%. Your client chooses to invest $75,000 of her portfolio in your equity fund and $75,000 in a T-bill money market fund. What is the expected return and standard deviation of return on your client's portfolio? (Round your answers to 2 decimal places.) Expected return 12.70 correct % Standard deviation 20.00 correct %

You manage an equity fund with an expected risk premium of 12.6% and a standard deviation of 40%. The rate on Treasury bills is 6.4%. Your client chooses to invest $75,000 of her portfolio in your equity fund and $75,000 in a T-bill money market fund. What is the expected return and standard deviation of return on your client's portfolio? (Round your answers to 2 decimal places.) Expected return 12.70 correct % Standard deviation 20.00 correct %