lational Investment Corporation has invested its portfolio as shown below. What is National's expected portfolio return? Asset Portfolio weight Expected return Money market securities 25% 8% Corporate bonds 30% 12% Equities 45% 9%
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Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
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- Below you can find the relevant financial information for Bristol Investments PLC during the latest financial year: Name: Bristol Investments PLC Capital Structure: all equity finance Earnings per Share (EPS): £4.5 Standard deviation of Returns: 25% Covariance with Market Portfolio: 0.026 The firm has just paid out its last dividend. The market portfolio has an expected return of 13% and an annual standard deviation of 23%. The annual risk-free rate is 5.5%. Assume that the expected returns are explained by the Capital Asset Pricing Model (CAPM). The firm’s expected growth in earnings per share is constantly at 2.2% and pays out all its earnings as dividends on an annual basis. Question: What is the required rate of return for Bristol Investments PLC?A company’s equity is valued at $10 million and debt is valued at $2 million. Its bonds tradeat the risk-free rate of 2%. If its WACC is 12.2% and its CAPM equity beta is 0.8, what must be theexpected rate of return on market portfolio? Assume that tax rate is 40%.As the Head of Investment for your company you are expected to compute the 10% value-at-risk for your company’s portfolio containing two categories of assets. The first category includes stocks which are traded on the Ghana Stock Exchange (GSE) with an expected return of 12% and Standard Deviation (SD) of 10% per annum. The second category contains GoG Bonds with an expected return of 15% and Standard Deviation (SD) of 3% per annum. The annual correlation between the two categories of assets is 70% or .7. The total portfolio value is US$5 million. The total investment in the Ghana stock exchange is US$3 million and US$2 invested in bonds. The Z-value for a normal distribution curve for 90% confidential level is 1.282. The formula for computing Expected Rp= Wg (Xg) + Wb(Xb) and variance is SDp2 = (Wg)(Wg)(SDg)(SDg) + (Wb)(Wb)(SDb)(SDb)+ (Wb)(Wb)(SDb)(SDb)+2(Wg)(Wb)(SDg)(SDb)(p) and to compute VaR = E(R)-Z-value(SDp) (Total Invested Amount) Compute the portfolio expected rate of rate…
- You have invested in the following portfolio: an amount of cash USD 111 earning 0.04 percent return. An amount of treasury bills USD 171, earning 0.07 percent return, an amount of bonds USD 150 earning 0.07 percent return. And an amount of stock USD 219 earning -0.11 percent return. Calculate the investment portfolio return..Calculate the weighted average expected return of the portfolio. Stock Investment Expected ReturnA $20,000 15%B $4,000 10%C $26,000 12%The financial controller is considering the use of the Capital Asset Pricing Model as a surrogate discount factor. The risk-free rate is 5 percent. The information in the table below has been used by company management in calculating the stock beta value which is 1.151and the expected return on the stock which is 12.5%.Year Stock Market Index share Price2011 2000 $15.002012 2400 $25.002013 2900 $33.002014 3500 $40.002015 4200 $45.002016 5000 $55.002017 5900 $62.002018 6000 $68.002019 6100 $74.002020 6200 $80.002021 6300 $83.33e) Calculate the CAPMf) Explain why this figure may differ from that calculated…
- A firm's stock has a beta of 1.75, Treasury bills yield 3.8%, and the market portfolio offers an expected return of 9.5%. In addition to equity, the firm finances 26% of its assets with debt that has a yield to maturity of 7.4%. The firm is in the 28% marginal tax bracket. Calculate the weighted average cost of capital.A mutual fund company has cash resources of birr 200 million for investment in a diversified portfolio. Table below shows the opportunity available, their estimated yields, risk factors and term period of details. Annual yield (%) Risk Factor Time period ( years) Bank deposit 9.5 0.02 6 treasury notes 8.5 0.01 4 corporate deposits 12.0 0.08 3 blue chip stocks 15.0 0.25 5 speculative stocks 32.5 0.45 3 real estates 35.0 0.04 10 Formulate the L.P. model to find the optimal portfolio that will maximize return, considering the following policy guidelines: i) All funds available may be invested ii) Weighted average period of at least 5 years should be the planning horizon iii) Weighted average risk factor must not exceed 0.20 iv) Investment in real estate and speculative stocks together must not be more than 25% of the money investedFor the above shares if the expected inter correlations are given as follows: Investment in RM millions Weight Correlation Petronas 23 ? 0.15(P,M) Maxis 47 ? 0.25(M,B) Berjaya 40 ? 0.35(B,P) d) Compute Weights e) Compute the expected portfolio return and f) Expected portfolio risk g) Portfolio Sharpe ratio
- The expected rate of return on a market portfolio is 7 percent. The riskless rate of interest is 4 percent. The beta of a company is 1.37. What is the required rate of return on this company's common equity?A firm's stock has a beta of 1.75, Treasury bills yield 3.8%, and the market portfolio offers an expected return of 9.5%. In addition to equity, the firm finances 26% of its assets with debt that has a yield to maturity of 7.4%. The firm is in the 28% marginal tax bracket. Calculate the firm’s risk premium.You have the following initial information on CMR Co. on which to base your calculationsand discussion for questions 1) and 2):• Current long-term and target debt-equity ratio (D:E) = 1:4• Corporate tax rate (TC) = 30%• Expected Inflation = 1.75%• Equity beta (E) = 1.6385• Debt beta (D) = 0.2055• Expected market premium (rM – rF) = 6.00%• Risk-free rate (rF) = 2.15%1) The CEO of CMR Co., for which you are CFO, has requested that you evaluate apotential investment in a new project. The proposed project requires an initial outlay of$7.15 billion. Once completed (1 year from initial outlay) it will provide a real net cashflow of $575 million in perpetuity following its completion. It has the same business riskas CMR Co.’s existing activities and will be funded using the firm’s current target D:Eratio.a) What is the nominal weighted-average cost of capital (WACC) for this project?