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State of the Economy Probability Recession 0.1 Below avg. 0.2 Average 0.4 Above avg. 02 Boom 0.1 Expected Return Standard Deviation Coefficient of Variation Beta T-Bills 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 0.0% 0.0 0.00 Returns on Alternative Investments U.S. High Tech Collections Rubber -29.5% 24.5% -9.5% 10.5% -16.5% 12.5% - 1.0% 0.5% 27.5% -5.0% 38.5% 42.5% -20.0% 23.5% 9.9% 1.2% 7.3% 20.0% 11.2% 18.8% 2.0 9.8 2.6 1.31 -0.50 0.88 Market portfolio - 19.5% -5.5% 7.5% 22.5% 35.5% 8.0% 15.2% 1.9 1.00 2-Stock Portfolio -2.5% 0.5% 5.8% 11.3% 11.3% 5.5% 4.6% 0.8 PARTB Suppose you created a 2-stock portfolio by investing $70,000 in High Tech and $30,000 in Collections. Calculate the expected return, the standard deviation, and the coefficient of variation for this portfolio and fill in the appropriate blanks in the table above. Investment Weight weight in High Tech 50% weight in Collections 50% State of the economy Recession Below average Average Above average Boom Portreturn -2.5% 0.5% 5.8% 11.3% 11.3% Portfolio return Port. std dev Port. CV 5.3% 5.6% 1.00 Correlation - -0.9889 PARTC The yield curve is currently flat; that is, long-term Treasury bonds also have a 3.0% yield. Consequently, Merrill Finch assumes that the risk-free rate is 3.0%. (1) Write out the SML equation, use it to calculate the required rate of return on each alternative, and graph the relationship between the expected and required rates of return. Risk-free rate 3.0% RP. If Beta-1 then: CAPM RP TNT TRE 3.0% 3.00% 1.31 + X TNT RP TAF 3.0% 3.00% B -0.50 X + X RP TUS TUR Tu TAF 3.0% 3.00% Bus 0.88 + X + TAF 3.0% 3.00% Broa 0.00 RP. + X State of the Economy Probability Recession 0.1 Below avg. 0.2 Average 0.4 Above avg. 02 Boom 0.1 Expected Return Standard Deviation Coefficient of Variation Beta T-Bills 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 0.0% 0.0 0.00 Returns on Alternative Investments U.S. High Tech Collections Rubber -29.5% 24.5% -9.5% 10.5% -16.5% 12.5% - 1.0% 0.5% 27.5% -5.0% 38.5% 42.5% -20.0% 23.5% 9.9% 1.2% 7.3% 20.0% 11.2% 18.8% 2.0 9.8 2.6 1.31 -0.50 0.88 Market portfolio - 19.5% -5.5% 7.5% 22.5% 35.5% 8.0% 15.2% 1.9 1.00 2-Stock Portfolio -2.5% 0.5% 5.8% 11.3% 11.3% 5.5% 4.6% 0.8 PARTB Suppose you created a 2-stock portfolio by investing $70,000 in High Tech and $30,000 in Collections. Calculate the expected return, the standard deviation, and the coefficient of variation for this portfolio and fill in the appropriate blanks in the table above. Investment Weight weight in High Tech 50% weight in Collections 50% State of the economy Recession Below average Average Above average Boom Portreturn -2.5% 0.5% 5.8% 11.3% 11.3% Portfolio return Port. std dev Port. CV 5.3% 5.6% 1.00 Correlation - -0.9889 PARTC The yield curve is currently flat; that is, long-term Treasury bonds also have a 3.0% yield. Consequently, Merrill Finch assumes that the risk-free rate is 3.0%. (1) Write out the SML equation, use it to calculate the required rate of return on each alternative, and graph the relationship between the expected and required rates of return. Risk-free rate 3.0% RP. If Beta-1 then: CAPM RP TNT TRE 3.0% 3.00% 1.31 + X TNT RP TAF 3.0% 3.00% B -0.50 X + X RP TUS TUR Tu TAF 3.0% 3.00% Bus 0.88 + X + TAF 3.0% 3.00% Broa 0.00 RP. + X

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