FIN321HW5

# Provide an evaluation of the investment performance

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Provide an evaluation of the investment performance of the three firms and make justified investment recommendations. Firm A: E(Ra) = Rf + Bi[E(Rm) – Rf] = .05 + .90[.15-.05] = .14 Sell this stock, it performs better than average realized return. Firm B: E(Rb) = .05 +1.1[.15-.05] = .16 Do not sell, as average realized return rate is same as expected return. Firm C:

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E(Rc) = .05 + 1.8[.15-.05] = .23 buy this stock as it is underpriced (lower than average realized return) 2. The following data have been compiled for a large Fortune 500 company j: State Probability r M r j I 0.1 -0.15 -0.30 II 0.2 0.05 0.00 III 0.3 0.15 0.20 IV 0.4 0.20 0.50 where r M denotes the market return and r j denotes the return of company j’s shares. The risk-free rate is 6%. a) Calculated the expected market return and variance and the expected return for company j and the covariance of j with the market return. E(rM) = .1(-.15) + .2(.05) + .3(.15) +.4(.20) = .12 Variance(rM) = .1(-.15 -.12)^2 - .2(.05 -.12)^2 + .3(.15-.12)^2 + .4(.2 -.12)^2 = .00729 + .00098 + .00027 +.00256 = .0111 E(rj) = .1(-.3) + .2(0) + .3(.2) + .4(.5) = -.03 + 0 + .06 +.2 = .23 Covariance(rj,rM) = .1(-.15-.12)(.3-.23) + .2(.05-.12)(0-.23) + .3(.15-.12)(.2-.23) + .4(.2-.12)(.5-.23) = -.01541 Beta = -.01541/.0111 = -1.4 b) Write the equation for the SML. What is the required return for company j? Should you buy the shares? E(r) = Rf + Bi(rM - Rf) = .06 + -1.4(.12-.06) = -.024 Sell the shares. 3. Using data downloaded for Homeworks 2 and 4…Download additional monthly closing figures for the S&P 500 Index for the period between December 2007 and December 2012 from Yahoo! (Ticker symbol: ^GSPC) a) Compute the companies’ betas from monthly returns for the time period between January 2008 and June 2010. How much of each stock’s risk is systematic risk? Beta GE: Jan 2008-June 2010 = 0.031628487 Beta McDonalds: Jan 2008-June 2010 = 0.000432477
b) Compute the companies’ betas for the time period between July 2010 and December 2012. Compare the betas for the two periods. Comment on your findings. Beta GE: 0.021579329 Beta McDonalds: 0.051681838
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