Risk & Return Name______________________ Score__________

The following probability distribution of expected returns have been determined for Benko Corporation

Probability Expected Returns (Outcomes)

.30 12%
.40 15%
.20 25%
.10 0%

First calculate the expected rate of return, r with ^
Now calculate the standard deviation
Then calculate the coefficient of variation

On a normal bell curve, 68.26% of the time, the actual returns will fall within +1 and -1 deviations of the expected rate of return, r with ^. Therefore, Benko’s actual rate of return should be no greater than__________% and no less than _________% 68.26% of the time. That is, within one deviation of the expected rate of return.

Use the letter in front of the statement to answer the questions that follow. Read all the options first. The letter may be used to answer more than one question.

 

A. It increases by 3%
B. It decreases by 3%
C. It increases, but not proportionately
D. It decreases, but not proportionately
E. No change, remains the same
F. The SML shifts upward, but the slope remains constant
G. The SML shifts downward, but the slope remains constant
H. The SML pivots upward, and the slope becomes steeper
I. The SML pivots downward, and the slope becomes flatter

ASSUME THAT INFLATION IS EXPECTED TO INCREASE BY 3% THIS YEAR.
1. ___What would happen to the risk free rate, rrf
2. ___What would happen to the market rate, rm
3. ___What would happen to the required rate, r
4. ___What would happen to the slope of the SML
5. ___What would happen to the risk free rate, rrf
6. ___What would happen to the market rate, rm
7. ___What would happen to the required rate, r
8. ___What would happen to the slope of the SML

There are three investment opportunities to consider. The forecasted risk-free rate is 9%, and the expected market rate is 13%.
What is the required rate of return, r, for each of the following scenarios. Show Work.

Assume investment A has a beta of .8
Assume investment B has a beta of 1.5
Assume investment C has a beta of 2.0

Which is the least risky investment? ____ Which is the most risky investment? ____

Calculate “r” the required rate of return for each of the following.

Assume beta is 1.3 for this and the next two problems, the risk-free rate is 6.5%, and market risk is 10.5%. Show work here. This is the original position.

Now assume the risk-free rate increases to 8% because inflation is expected to increase next year. Show work here.

What will happen to the slope of the SML because of this? Choose ONE from each group.
What will happen to the slope of the SML because of this? Choose ONE from each group.

Based on what you know about risk, determine which of the following exposes the investor to more risk. First calculate the coefficient of variation for each. Show work next to each. Which is the riskiest? Explain

 

Company A has an expected rate of return of 12% and a standard deviation of 3%.
Company B has an expected rate of return of 8% and a standard deviation of 2%.
Company C has an expected rate of return of 20% and a standard deviation of 5%.

If the correlation coefficient, p, is equal to +1.0, perfectly positively correlated, has diversification worked? Yes or No Is this a risky portfolio? Yes or No

If the correlation coefficient, p, is equal to -1.0, perfectly positively correlated, has diversification worked? Yes or No Is this a risky portfolio? Yes or No

Suppose you are the manager of a $10,000,000 investment fund. The fund consists of 4 stocks with the following investments and beta coefficients:

Stock A $3,000,000 beta 1.5
Stock B $2,000,000 beta 1.0
Stock C $4,000,000 beta 0.5
Stock D $1,000,000 beta 2.0

If the market’s required rate of return (rm) is 13% and the risk-free rate(rRF) is 6%, what is the funds required rate of return, r? You must first find the beta for the portfolio. Then use it to calculate the required rate of return using the SML equation. Show work here.