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End of Chapter Key

Chapters 4,5,6 and8

Chapter 4

23.

A. PV = $18,000; FV = $30,000; N=5

Using Financial Calculator (HP 10BII), find rate of return in this investment

18,000 +/- PV

30,000 FV

5 N

I/YR 10.75%

Since 10.75% > 10.0% Acceptable investment

B. I/YR 8.73%

Since 8.73% < 10.0% Unacceptable investment

C. I/YR 11.06%

Since 11.06% > 10.0% Acceptable investment

D. . I/YR 7.0%

Since 7.0% < 10.0% Unacceptable investment

29. Holding period return (HPR) Ñ"­

If the investments are held beyond a year, the capital gain (loss) component would not be realized and would likely change. Assuming they are of equal risk, Investment Y would be preferred since it offers the higher return (16.0% for Y versus 11.67% for X).

43. (a) Investment A, with returns that vary widelyÐŽXfrom 1% to 26%ÐŽXappears to be more risky than Investment B, whose returns vary from 8% to 16%.

(b)

Investment A:

(1) (2) (3) (4)

Return Average (1) ÐŽV (2) (3)2

Year r i Return, r ri ÐŽV r (ri ÐŽV r)2

2001 19% 12% 7% 49%

2002 1 12 ÐŽV11 121

2003 10 12 ÐŽV2 4

2004 26 12 14 196

2005 4 12 ÐŽV8 64

434

Investment B:

(1) (2) (3) (4)

Year Return Average (1) ÐŽV (2) (3)2

r i Return, r ri ÐŽV r (ri ÐŽV r)2

2001 8% 12% ÐŽV4% 16%

2002 10 12 ÐŽV2 4

2003 12 12 0 0

2004 14 12 2 4

2005 16 12 4 16

40

(c) Investment A, with a standard deviation of 10.42, is considerably more risky than Investment B, whose standard deviation is 3.16. This confirms the conclusions reached in Part A.

(d) Because the real benefit of calculating the coefficient or variation is in comparing investments that have different average returns, the standard deviation is not improved upon.

Chapter 5

3. (a) Average portfolio return for each year: rp Ñ"­ (wL „e rL) Ñ"y (wM „e rM)

Year Asset L

(wL „e rL) Ñ"y Asset M

(wM „e rM) Ñ"­ Expected

Portfolio Return

rp

2006 (14% „e 0.40 Ñ"­ 5.6%) Ñ"y (20% „e 0.60 Ñ"­ 12.0%) Ñ"­ 17.6%

2007 (14% „e 0.40 Ñ"­ 5.6%) Ñ"y (18% „e 0.60 Ñ"­ 10.8%) Ñ"­ 16.4%

2008 (16% „e 0.40 Ñ"­ 6.4%) Ñ"y (16% „e 0.60 Ñ"­ 9.6%) Ñ"­ 16.0%

2009 (17% „e 0.40 Ñ"­ 6.8%) Ñ"y (14% „e 0.60 Ñ"­ 8.4%) Ñ"­ 15.2%

2010 (17% „e 0.40 Ñ"­ 6.8%) Ñ"y (12% „e 0.60 Ñ"­ 7.2%) Ñ"­ 14.0%

2011 (19% „e 0.40 Ñ"­ 7.6%) Ñ"y (10% „e 0.60 Ñ"­ 6.0%) Ñ"­ 13.6%

(b) Portfolio Return:

(c) Standard Deviation:

(d) The assets are negatively correlated.

(e) By combining these two negatively correlated assets, overall portfolio risk is reduced.

18. If the risk-free rate is 7% and the market return is 12%.

(a) Vehicle E is the most risky because it has the highest beta, 2.00. Vehicle D, with a beta of 0, is the least risky.

(b) Capital Asset Pricing Model: ri Ñ"­ RF Ñ"y [bi „e (rm ÐŽV RF)]

Investment ri RF Ñ"y [bi „e (rm ÐŽV RF)]

&#8195;&#8195;A 14.5% Ñ"­ 7% Ñ"y [1.50 „e (12% ÐŽV 7%)]

&#8195;&#8195;B 12% Ñ"­ 7% Ñ"y [1.00 „e (12% ÐŽV 7%)]

&#8195;&#8195;C 10.75% Ñ"­ 7% Ñ"y [0.75 „e (12% ÐŽV 7%)]

&#8195;&#8195;D 7% Ñ"­ 7% Ñ"y [0 „eÑ"nÑ"vÑ"ÐŽÑ"ÑžÑ"sÑ"nÑ"{Ñ"nÑ"§Ñ"sÑ"wÑ"Н

&#8195;&#8195;E 17% Ñ"­ 7% Ñ"y [2.00 „e (12% ÐŽV 7%)]

(c) The figure showing the security market line (SML) can be found on the bookÐŽ¦s Web site at www.awl.com/gitman_joehnk.

(d) Based on the above graph and the calculations, there is a linear relationship between risk and return.

22. (a)

Stock Beta

Most risky B 1.40

A 0.80

Least risky C ÐŽV0.30

(b) and (c).

Stock Beta Increase

...

...

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