Consider the following scenario analysis: Rate of Return Scenario Probability Stocks Bonds Recession 0.20 -4% 19% Normal economy 0.40 20% 9% Boom 0.40 26% 8% a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? O No O Yes b. Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.) Expected Rate of Return Standard Deviation Stocks % Bonds % % E. Which investment would you prefer? Stock Bond Which investment would you prefer?

Consider the following scenario analysis: Rate of Return Scenario Probability Stocks Bonds Recession 0.20 -4% 19% Normal economy 0.40 20% 9% Boom 0.40 26% 8% a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? O No O Yes b. Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.) Expected Rate of Return Standard Deviation Stocks % Bonds % % E. Which investment would you prefer? Stock Bond Which investment would you prefer?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 20P

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Suppose there is a large probability that L will default on its debt. For the purpose of this example, assume that the value of Ls operations is 4 million (the value of its debt plus equity). Assume also that its debt consists of 1-year, zero coupon bonds with a face value of 2 million. Finally, assume that Ls volatility, , is 0.60 and that the risk-free rate rRF is 6%.
Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the yield on T-bonds) is 7.0%, and that the market risk premium is 5%. What is the required rate of return on the firms stock?
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Consider the following scenario analysis: Rate of Return Scenario Probability Stocks Bonds Recession 0.30 −5 % 18 % Normal economy 0.60 19 % 7 % Boom 0.10 24 % 7 % a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? multiple choice No Yes b. Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.) c. Which investment would you prefer?
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The following question illustrates the APT. Imagine that there are only two pervasive macroeconomic factors. Investments X, Y, and Z have the following sensitivities to these two factors: Investment b1 b2 X 1.75 0 Y −1.00 2.00 Z 2.00 1.00 We assume that the expected risk premium is 7.8% on factor 1 and 11.8% on factor 2. Treasury bills obviously offer zero risk premium. According to the APT, what is the risk premium on each of the three stocks? Suppose you buy $500 of X and $125 of Y and sell $375 of Z. What is the sensitivity of your portfolio to each of the two factors? What is the expected risk premium? Suppose you buy $200 of X and $150 of Y and sell $100 of Z. What is the sensitivity of your portfolio to each of the two factors? What is the expected risk premium? Finally, suppose you buy $400 of X and $50 of Y and sell $200 of Z. What is your portfolio's sensitivity now to each of the two factors? And what is the expected risk premium?