Financial Risk

1. Compare the stand-alone risk/return of each of the five investment alternatives listed in Exhibit 13.1.

2. MSI is considering two investment strategies:

-50 percent in Project A and 50 percent in Project B (Portfolio A/B) or

-50 percent in Project A and 50 percent in the S&P 500 Fund (Portfolio A/S&P). Compare the risk of the two portfolios. Why does the risk differ?

3.

a.

b.

Compare the corporate risk of Projects A and B. (Hint: Use the expected returns in Exhibit 13.1 to create a graph with corporate characteristic lines for Projects A and B. Regression lines can be created using the = INTERCEPT and = SLOPE functions in Excel. The XY (Scatter) chart in Excel is recommended.)

What would happen to the overall risk of MSI if it invests in Project A? Project B?

4.

a.

b. c.

Compare the market risk of a 1-year T-Bill, Project A, Project B, and equity in MSI.(Hint: Use the historical returns in Exhibit 13.2 to create a graph with market characteristic lines for a 1-year T-Bill, Project A, Project B, and equity in MSI.)

What would happen to the overall risk of a well-diversified portfolio with an investment in a 1-Year

T-Bill? Project A? Project B? Equity in MSI?

What does the distance between the market characteristics line and the expected return of an investment indicate?

5.

a.

b.

If you were an individual investor with a well-diversified portfolio, which investment(s) in Exhibit 13.1 would you buy? Why?(Inreality, MSI is a not-for-profit corporation, so it would be impossible to buy an equity interest in the firm. For this question, assume that MSI is an investor-owned company.) (Hint: construct a Security Market Line graph and plot the expected return of each investment on the graph.)

What does the distance between the SM Land the expected return of an investment indicate?

6.

a. b.

c.

Is the return on the one-year T-bill risk free?

SupposeMSIwantstoconstructaportfolioofstocksthathasanexpectedreturnequaltotherisk- free rate. Is such a portfolio possible?Is such a portfolio likely?

Suppose that you choose to hold a single stock investment in isolation.Would you be compensated for all of the risk that you assume?Explain.

7. In your opinion, what are three key learning points from this case?