Chp 12 Finance - ExpectedReturnExample...

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Expected Return Example State of Economy Stock C Stock T Boom 0.25 15.00% 10.00% Normal 0.6 10.00% 9.00% Recession 0.15 5.00% 10.00% Expected Return Stock C= 10.5% Stock T= 9.4% Variance and Standarad Deviation Stock C Variance 9.75 Standard Dev 3.12% Stock T Variance 0.24 Standard Dev 0.49% Stock Best Case Base Case Worst Case Stock C 13.62% 10.50% 7.38% Stock T 9.89% 9.40% 8.91% Stock T has higher volatility Portfolio Weight $ Invested % Invested Total Stock Investments 20000 GE 12000 0.6 IBM 8000 0.4 Portfolio Expected Returns Step 1: $ Invested Weight Invested Total Invested 15000 Cisco 2000 0.133 19.69% Coca Cola 3000 0.200 5.25% Intel 4000 0.267 16.65% Keithley Instruments 6000 0.400 18.24% Step 2: 15.41% ANSWER Portfolio Variance $ Spent Weight Invested Boom Return Probability of that state  (assumption) Expected Returns  (Given) Portfolio's Expected  Returns *Assume both stocks  have been purchased*
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Total Spent 10000 Stock C 6000 0.6 15.00% Stock T 4000 0.4 10.00% 25% Boom= 13.00% Normal= 9.60% Recession= 7.00% Expected Variance= 10.0600% Best Variance= 0 11.9816% Stan Dev= 1.92% Total Risk vs Systematic Risk Stan Dev Beta Security C 20.00% 1.25 Security K 30.00% 0.95 More Total Risk? K, b/c  Standard Dev More Systematic Risk? C, B/C of beta C, B/C of beta and systematic risk Portfolio Betas Security Total Invested Weight Expected Return $15,000.00 CSCO 0.13 19.69% KO 0.2 5.25% INTC 0.27 16.65% KEI 0.4 18.24% Portfolio Return= 15.41% Portfolio Beta= 1.947 Risk to Reward Ratio Expected Return 20.00% Risk Free Rate 8.00% Beta 1.6 Risk to Reward Ratio= 7.50% <---Premium (@ >7.5, Investors rush to buy) Portfolio Returns by  state of economy Likelihood of this  state of economy Overall Portfolio  Return Higher Expected  Return? <----Therefore there is systematic risk tha than the market. 
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(@ <7.5, Investorsrush to sell) (@ 7.5 trading would cease) Market Equilibrium Security Market Line Any Asset must Plot on security market line Capital Asset Pricing Model consists of: R(f)= Pure Time Value of $ (E(Rm-Rf)) Reward for Systematic Risk B(a) Systematic Risk Capital Asset Pricing Model Risk Free Rate= 2.13% Risk Premium= 8.60% Security Beta Expected Return CSCO 2.69 25.22% KO 0.2 3.81% INTC 2.16 20.71% KEI 2.43 23.06% Expected Return 15.78% Beta 1.62 Risk Premium 11.34% Risk Free Rate 3.22% 3.59% 3.63% 21.59% 21.96% 22.00% 28.78% 29.15% 29.19% Expected Return Possibility 1 Invested $10,000.00 Stock X 13.00% 800 Stock Y 8.00% $9,200.00 Portfolio Goal 12.40% The expected return on JK stock is 15.78 percent while the expected return on the market is 11.34
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This note was uploaded on 07/31/2011 for the course FIN 550 taught by Professor Rajneeshsharma during the Summer '11 term at Saint Joseph's University.

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Chp 12 Finance - ExpectedReturnExample...

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