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Lecture 4

MGT 200 Lecture 4: HW Study Questions
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Department
Management
Course
MGT 200
Professor
Laufenberg
Semester
Spring

Description
Chapter 5 Suppose your expectations regarding the stock market are as follows: State of the Economy Probability HPR Boom 0.3 40% Normal growth 0.4 7 Recession 0.3 –23 Use Equations to compute the mean and , standard deviation of the HPR on stocks. E(r) = 0.3*.4 + 0.4*0.07 + 0.3*-0.023 = 7.9% Standard deviation = 0.3(0.4-.079)2 + 0.4(0.07-.079)2 + 0.3(-0.23-.079)2 = 24.41% The stock of Business Adventures sells for $72 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows: Dividend Stock price Boom $ 3.00 $ 82 Normal economy 2.00 75 Recession 1.50 66 Required: (a) Calculate the expected holding-period return and standard deviation of the holding-period return. All three scenarios are equally likely. 3 + 72 – 82 / 82 = -8.537% 2 + 72 – 75 / 75 = -1.33% 1.5 + 72 – 66 / 66 = 11.36% 1/3-.08537 + 1/3*.01333 + 1/3* .1136 = Standard deviation of the HPR 1/3(.08537) + 1/3(.01333) + 1/3(.1136) = Chapter 6 A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long- term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 5.0%. The probability distributions of the risky funds are: Expected Return Standard Deviation Stock fund (S) 11% 40% Bond fund (B) 6% 20% The correlation between the fund returns is .0500. What is the expected return and standard deviation for the minimum-variance portfolio of the two risky funds? Wa = [.2^2 – (.05*.4*.2)] / [.4^2 + .2^2 – 2*(.05*.4*.2)] = 18.75% Er = .1875 * .11 + .8125 * .06 = 6.94% St dev = (.1875*.4)^2 + (.8125*.2)^2 + 2*(.8125*.1875*.4*.2*.05) = 18.23% A project has a 0.92 chance of doubling your investment in a year and a 0.08 chance of halving your investment in a year. What is the standard deviation of the rate of return on this investment? 0.92*1 + .08*-.5 = .88 .92(1-.88)^2 + .08(-.5-.88)^2 = Chapter 7 Here are data on two companies. The T-bill rate is 6.0% and the market risk premium is 7.7%. Company $1 Discount Store Everything $5 Forecast return 15% 14% Standard deviation of returns 18% 20% Beta 1.7 1 What would be the fair return for each company, according to the capital asset pricing model (CAPM)? $1 Discount Store = .06 + 1.7*.077 = 19.09% Everything $5 = .06 + 1*.077 = 13.7% What must be the beta of a portfolio with EPr ) = 12.00%, ff r = 4% and M(r ) = 12%? .12 = .04 + B*(.12-.04) B =1 You are a consultant to a large manufacturing corporation considering a project with the following net after-tax cash flows (in millions of dollars): Years from Now After-Tax CF 0 –22 1–9 10 10 20 The project's beta is 1.6. Assuming f = 5% and E(rM) = 15%. a. What is the net present value of the project? Er = r + B(Erm – rf) = .05 + 1.6(.15-.05) = 21% CF0 = -22 CF1 =
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