Laura Spegele is considering purchasing a stock that youbelieve will offer an inferior return for the risk she willbear. To convince her that her acquisition is not desirable,you want to demonstarte the trade-off between risk andreturn.
Currently U.S treasury bills offer 7%. Three possible stocksand their betas are as follows:
Security ExpectedReturn Beta
StockA 9% 0.6
StockB 11 1.3
StockC 14 1.5
T-bills no beta = 0
1. What will be the expected return and beta for each of thefollowing portfolio's?
a) Portfolio's 1-4 : All of the funds are invested soleyin one asset (the corresponding three stocks or the TreasuryBill)
b) Portfolio 5: One-quarter of the funds are invested in eachalternative.
c) Portfolio 6: One-half of the funds are invested in Stock Aand one-half in Stock C.
d) Portfolio 7: One-third of the funds are invested in eachstock.
2. Are any of the portfolio's inefficient?
3. Is there any combination of the Treasury Bill Stock C thatis superior to portfolio 6(i.e., half the funds in stock A and halfin stock C)?
4. Since your client's suggested stock has an anticipatedreturn of 12 percent and a beta of 1.4, does that information arguefor or against the purchase of the stock> Compare.
5. Why is it important to consider purchasing an asset as partof a portfolio and not as an independent act?