Finance Investment Analysis

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FROM BOOK — Reilly, F., & Brown, K. (2012). Investment analysis & portfolio management (10th ed.). Mason, OH: South-Western Cengage Learning.

Chapter 8 – questions 3,4,5,6,7 and 10

3  The capital asset pricing model (CAPM) contends that there is systematic and unsystematic risk for an individual security. Which is the relevant risk variable and why is it relevant? Why is the other risk variable not relevant? 100 words

4  What are the similarities and differences between the CML and SML as models of the risk-return trade-off? 100 words

5  While the capital asset pricing model (CAPM) has been widely used to analyze securities and manage portfolios for the past 50 years, it has also been widely criticized as providing too simple a view of risk. Describe three problems in relation to the definition and estimation of the beta measure in the CAPM that would support this criticism.150 words

6  You have been offered an opportunity to invest in one of the two fully diversified portfolios, Portfolio H and Portfolio L. While you know that the betas of these portfolios are identical, you only know that, on average, the stocks held in Portfolio H have a higher level of specific risk than those in Portfolio L. From what you know about the capital asset pricing model (CAPM), which portfolio should you invest in? Which portfolio should give you a higher expected return? 100 words

7  You have recently appointed chief investment officer of a major charitable foundation. Its large endowment fund is currently invested in a broadly diversified portfolio of stocks (60 percent) and bonds (40 percent). The foundation’s board of trustees is a group of prominent individuals whose knowledge of modern investment theory and practice is superficial. You decide a discussion of basic investment principles would be helpful.

                A  — Explain the concepts of specific risk, systematic risk, variance, covariance, standard deviation, and beta as they relate to investment management. 200 words

You believe that the addition of other asset classes to the endowment portfolio would improve the portfolio by reducing risk and enhancing return. You are aware that depressed conditions in U.S. real estate markets are providing opportunities for property acquisition at levels of expected return that are unusually high by historical standards. You believe that an investment in U.S. real estate would be both appropriate and timely, and have decided to recommend a 20 percent position be established with funds taken equally from stocks and bonds. Preliminary discussions revealed that several trustees believe real estate is too risky to include in the portfolio. The board chairman, however, has scheduled a special meeting for further discussion of the matter and has asked you to provide background information that will clarify the risk issue.

To assist you, the following expectational data have been developed:

Correlation Matrix
Assets Class	Return	Standard Deviation	U.S. Stocks	U.S. Bonds	U.S. Real Estate	U.S. T-Bills
U.S. Stocks	12.0%	21.0%	1.00
U.S. Bonds	8.0	10.5	0.14	1.00
U.S. Real State	12.0	9.0	-0.04	-0.03	1.00
U.S. Treasury Bills	4.0	0.0	-0.05	-0.03	0.25	1.00

B — Explain the effect on both portfolio risk and return that would result from the addition of U.S. real estate. Include in your answer two reasons for any change you expect in portfolio risk. (Note: It is not necessary to compute expected risk and return.) 200 words

C — Your understanding of capital market theory causes you to doubt the validity of the expected return and risk for U.S. real estate. Justify your skepticism. 70 words

10  Some studies related to the efficient market hypothesis generated results that implied additional factors beyond beta should be considered to estimate expected returns. What are these other variables and why should they be considered? 150 words

Chapter 8 problems 5a and 5b (no need to plot them on the SML for 5b), and 6a,b,c .

5  Based on five years of monthly data, you derive the following information for the companies listed:

Company	ai (intercept)	∂i	rim
Intel	0.22	12.10%	0.72
Ford	0.10	14.60	0.33
Anheuser Busch	0.17	7.60	0.55
Merck	0.05	10.20	0.60
S&P 500	0.00	5.50	1.00

A — Compute the beta coefficient for each stock.

B – Assume a risk-free rate of 8 percent and an expected return for the market portfolio of 15 percent, compute the expected (required) return for all the stocks.

6  The following are the historic returns for the Chelle Computer Company:

Year	Chelle Computer	General Index
1	37	15
2	9	13
3	-11	14
4	8	-9
5	11	12
6	4	9

Based on this information, compute the following:

A – The correlation coefficient between Chelle Computer and the General Index.

B – The standard deviation for the company and the index.

C – The beta for the Chelle Computer Company.

Chapter 10, complete questions 3,4,5,9, and 10

3  Besides comparing a company’s performance to its total industry, discuss what other comparisons should be considered within the industry. 200 words

4  How might a jewelry store and a grocery store differ in terms of asset turnover and profit margin? Would you expect their return on total assets to differ assuming equal business risk? Discuss. 100 words

5  Describe the components of business risk, and discuss how the components affect the variability of operating earnings (EBIT). 100 words

9  Why is the analysis of growth potential important to the common stockholder? Why is it important to the debt investor? 100 words

10  Discuss the general factors that determine the rate of growth of any economic unit. 150 words

 

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