Mindtap For Brigham/ehrhardt's Financial Management: Theory & Practice, 1 Term Printed Access Card (mindtap Course List)
16th Edition
ISBN: 9781337909655
Author: Eugene F. Brigham, Michael C. Ehrhardt
Publisher: Cengage Learning
expand_more
expand_more
format_list_bulleted
Videos
Question
Chapter 25, Problem 2MC
Summary Introduction
Plot: Attainable portfolios for the correlation +0.35, +1.0 and -1.0.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Kindly solve it ASAP
Two portfolio managers, Mr. P and Mr. Q, claim that they are both good at picking under-priced stocks. Over the years, the average return on the portfolio managed by Mr. P has been 17%, with standard deviation 15%, while the average return of Mr. Q's portfolio has been 18%, with standard deviation 17%. Over the same period, the average return on the market portfolio has been 15%, with standard deviation 12%. You estimate that the covariance between Mr. P's portfolio and the market has been sPM=0.0173, while the covariance between Mr. Q's portfolio and the market has been sQM=0.0202. Finally, you estimate that the average return on money market funds (a proxy for the risk-free rate of return) has been 5%.
a. Compute the expected returns on Mr. P's and Mr. Q's portfolios that would be consistent with Market Model (ie: alpha equals zero under the Market Model).
b. Given the Market as the benchmark, are either of the two managers over-performing the market?…
An analyst who believes in the Treynor Black Model has identified one active stock, stock A, which he/she wants to combine with the passive Market Index M to form their firm's optimal risky portfolio. A regression of the excess returns of stock A on the excess returns of the market index M, have discovered that stock A's alpha is 4%, its beta is 2.0, and the residual standard deviation of the error term for stock A is 18%. The standard deviation for the market index M is 14%, the expected return on M is 11%, the risk-free rate of return is 3%, and the expected return on stock A is 22%. What is the Sharpe Ratio for the optimal risky portfolio formed by the optimal combination of the active stock A with the passive market index M? Note that the Sharpe Ratio is usually expressed as a decimal.
Bart Campbell, CFA, is a portfolio manager who has recently met with a prospective client, Jane Black. After conducting a survey market line (SML) performance analysis using the Dow Jones Industrial Average as her market proxy, Black claims that her portfolio has experienced superior performance. Campbell uses the capital asset pricing model as an investment performance measure and finds that Black’s portfolio plots below the SML. Campbell concludes that Black’s apparent superior performance is a function of an incorrectly specified market proxy, not superior investment management. Justify Campbell’s conclusion by addressing the likely effects of an incorrectly specified market proxy on both beta and the slope of the SML.
Chapter 25 Solutions
Mindtap For Brigham/ehrhardt's Financial Management: Theory & Practice, 1 Term Printed Access Card (mindtap Course List)
Ch. 25 - Define the following terms, using graphs or...Ch. 25 - Prob. 2QCh. 25 - The standard deviation of stock returns for Stock...Ch. 25 - Prob. 2PCh. 25 - Stock A has an expected return of 12% and a...Ch. 25 - Prob. 4PCh. 25 - Prob. 7SPCh. 25 - Prob. 1MCCh. 25 - Prob. 2MCCh. 25 - Prob. 3MC
Ch. 25 - You have been hired at the investment firm of...Ch. 25 - You have been hired at the investment firm of...Ch. 25 - Prob. 6MCCh. 25 - You have been hired at the investment firm of...Ch. 25 - You have been hired at the investment firm of...Ch. 25 - Prob. 9MCCh. 25 - You have been hired at the investment firm of...Ch. 25 - Prob. 11MC
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- You have been hired at the investment firm of Bowers Noon. One of its clients doesnt understand the value of diversification or why stocks with the biggest standard deviations dont always have the highest expected returns. Your assignment is to address the clients concerns by showing the client how to answer the following questions: Add a set of indifference curves to the graph created for part b. What do these curves represent? What is the optimal portfolio for this investor? Add a second set of indifference curves that leads to the selection of a different optimal portfolio. Why do the two investors choose different portfolios?arrow_forwardYou have been hired at the investment firm of Bowers Noon. One of its clients doesnt understand the value of diversification or why stocks with the biggest standard deviations dont always have the highest expected returns. Your assignment is to address the clients concerns by showing the client how to answer the following questions: e. Add a set of indifference curves to the graph created for part b. What do these curves represent? What is the optimal portfolio for this investor? Add a second set of indifference curves that leads to the selection of a different optimal portfolio. Why do the two investors choose different portfolios?arrow_forwardYou have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: Construct a plausible graph that shows risk (as measured by portfolio standard deviation) on the x-axis and expected rate of return on the y-axis. Now add an illustrative feasible (or attainable) set of portfolios and show what portion of the feasible set is efficient. What makes a particular portfolio efficient? Don’t worry about specific values when constructing the graph—merely illustrate how things look with “reasonable” data.arrow_forward
- You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: Suppose a risk-free asset has an expected return of 5%. By definition, its standard deviation is zero, and its correlation with any other asset is also zero. Using only Asset A and the risk-free asset, plot the attainable portfolios.arrow_forwardYou have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: Write out the equation for the Capital Market Line (CML), and draw it on the graph. Interpret the plotted CML. Now add a set of indifference curves and illustrate how an investor’s optimal portfolio is some combination of the risky portfolio and the risk-free asset. What is the composition of the risky portfolio?arrow_forwardYou have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: What are two potential tests that can be conducted to verify the CAPM? What are the results of such tests? What is Roll’s critique of CAPM tests?arrow_forward
- You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: What is the Capital Asset Pricing Model (CAPM)? What are the assumptions that underlie the model? What is the Security Market Line (SML)?arrow_forwardKaren Kay, a portfolio manager at Collins Asset Management, is using thecapital asset pricing model (CAPM) for making recommendations to her clients.Her research department has developed the information shown in the followingexhibit.Forecast Returns, Standard Deviations, and BetasForecast Return Standard Deviation BetaLow β stock (X) 14.0% 36% 0.8High β stock (Y) 17.0% 25% 1.5Market index 14.0% 15% 1.0Risk-free rate 5.0%(a) Calculate expected return and alpha for each stock.(b) Identify and justify which stock would be more appropriate for an investorwho wants to add this stock to a well-diversified equity portfolio.(c) Now consider Karen employs the “Betting Against Beta” strategy and let, , and denote the portfolio weights of the investmentin each of the asset classes (e.g. risk-free asset, low beta stock, market index,high beta stock, respectively) such that .According to its investment mandate, Collins Asset Management shouldtarget a gross leverage of 2.3. How much does she have to…arrow_forwardWhich of the following statements is CORRECT? 1. a. Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time. 2. d. Tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable. 3. c. Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the CAPM. 4. e. The most widely cited study of the validity of the CAPM is one performed by Modigliani and Miller. 5. b. Richard Roll has argued that it is possible to test the CAPM to see if it is correctarrow_forward
- A portfolio manager summarizes the input from the macro and micro forecasters in the following table: Micro Forecasts Asset Expected Return (%) Beta Residual Standard Deviation (%) Stock A 27 0.8 59 Stock B 12 1.2 69 Stock C 11 0.5 62 Stock D 9 0.6 54 Macro Forecasts Asset Expected Return (%) Standard Deviation (%) T-bills 6 0 Passive equity portfolio 12 20 Calculate the following for a portfolio manager who is not allowed to short sell securities. If allowed to short sell securities, the manager's Sharpe ratio is 0.4085.a. What is the cost of the restriction in terms of Sharpe’s measure? (Do not round intermediate calculations. Enter your answer as decimals rounded to 4 places.) b. What is the utility loss to the investor (A = 3.0) given his new complete portfolio? (Do not round intermediate calculations. Round your answers to 2 decimal places.)arrow_forward“In investing, risk and return are highly correlated. Increased potential returnson investment usually go hand-in-hand with increased risk”. Critically evaluatethe above statement.ii A Financial Analyst is analyzing two investment alternatives Y and Z. Theirrates of returns under different probabilities are as follows.Probability Rate of ReturnY Z0.2 22% 5%0.6 14% 15%0.2 -4% 25%a. For Y and Z, calculate expected return, variance and standard deviation.b. Calculate the coefficient of variation for both stocks.c. If you are an investor, which company you would select for theinvestment.arrow_forwardDuring a particular year, the T-bill rate was 6%, the market return was 14%, and a portfolio manager with beta of .5 realized a return of 10%.a. Evaluate the manager based on the portfolio alpha.b. Reconsider your answer to part (a) in view of the Black-Jensen-Scholes finding that the security market line is too flat. Now how do you assess the manager’s performance?arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Chapter 8 Risk and Return; Author: Michael Nugent;https://www.youtube.com/watch?v=7n0ciQ54VAI;License: Standard Youtube License