EBK INVESTMENTS
11th Edition
ISBN: 9781259357480
Author: Bodie
Publisher: MCGRAW HILL BOOK COMPANY
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Chapter 13, Problem 3CP
Summary Introduction
To determine: The Campbell’s conclusion is to be justified by addressing the presumable impacts of a mistakenly indicated market proxy on both beta and slope of the SML.
Introduction: MarketLine, previously known as Datamonitor, is growing the substance and usefulness of its MarketLine Advantage look into database. The administration is intended for the board advisors, venture investors, exchange offices, legal advisors, and scholastic research. MarketLine distributes industry look into at the nation, territorial, and worldwide level enabling clients to think about a similar industry in various nations or numerous enterprises inside a nation.
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a. John Wilson is a portfolio manager at Austin & Associates. For all of his clients, Wilson manages portfolios that lie on the Markowitz efficient frontier. Wilson asks Mary Regan, CFA, a managing director at Austin, to review the portfolios of two of his clients, the Eagle Manufacturing Company and the Rainbow Life Insurance Co. The expected returns of the two portfolios are substantially different. Regan determines that the Rainbow portfolio is virtually identical to the market portfolio and concludes that the Rainbow portfolio must be superior to the Eagle portfolio. Do you agree or disagree with Regan’s conclusion that the Rainbow portfolio is superior to the Eagle portfolio? Justify your response with reference to the capital market line.b. Wilson remarks that the Rainbow portfolio has a higher expected return because it has greater nonsystematic risk than Eagle’s portfolio. Define nonsystematic risk and explain why you agree or disagree with Wilson’s remark.
Sharon Smith, the financial manager for Barnett Corporation, wishes to select one of three prospective investments: X, Y, and Z. Assume that the measure of risk Sharon cares about is an asset's standard deviation. The expected returns and standard deviations of the investments are as follows:
Investment
Expected
return
Standard
deviation
X
17%
7%
Y
17%
8%
Z
17%
9%
a. If Sharon were risk neutral, which investment would she select? Explain why.
b. If she were risk averse, which investment would she select? Why?
c. If she were risk seeking, which investments would she select? Why?
d. Suppose a fourth investment, W, is available. It offers an expected return of 18%,and it has a standard deviation of 9%. If Sharon is risk averse, can you say which investment she will choose? Why or why not? Are there any investments that you are certain she will not choose?
A professional investor that you know makes the followingobservation about the assets on his portfolio. “From experience and repeatedobservation of the assets in my portfolio, I have discovered that the variance ofreturns on the individual assets are quite small and not at all as large I thoughtinitially when I invested in them.” How would you judge this observation if youbelieved that the investor is hindsight biased but might not be aware of it?What implications does this have for the efficient markets hypothesis.
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