Graded Homework

You have recently graduated with a
major in finance and landed a financial planner job with Barney Smith Inc., a
large financial services corporation. Your first assignment is to invest
$100,000 for a client. Because the funds will be invested in a new business the
client plans to start at the end of the year, you have been instructed to plan
for a 1-year holding period. Further, your boss has restricted you to the
investment alternatives shown in Table 1 on the attached resource, “Topic
5 Assignment Graphic Tables.” (Disregard for now the items at the bottom
of the data; you will fill in the blanks later.)

Note that the estimated returns of
American Foam (Am. Foam), a bedding company, do not always move in the same
direction as the overall economy. For example, when the economy is below
average, consumers purchase fewer mattresses than they would if the economy
were stronger. However, if the economy is in a flat-out recession, a large
number of consumers who were planning to purchase a more expensive inner-spring
mattress may purchase a cheaper foam mattress instead. Under these
circumstances, we would expect American Foam’s stock price to be higher if
there is a recession than if the economy was just below average.

Barney Smith’s economic forecasting
staff has developed probability estimates for the state of the economy, and its
security analysts have developed a sophisticated computer program that was used
to estimate the rate of return on each alternative under several state of the
economy scenarios. Alta Industries (Alta Inds) is an electronics firm; Repo Men
collects past-due debts; and American Foam, as per above, manufactures
mattresses and various other foam products. Barney Smith also maintains an
“index fund” which owns a market-weighted fraction of all publicly
traded stocks; you can invest in that fund, and thus obtain average stock
market results.

Given the situation as described,
answer the following questions.

1. Describe investment returns, and what
   “best case” and “worst case” returns you might hope to
   achieve for your new client. What is the return on an investment that
   costs $1,000 and is sold after one year for $1,100? Would you recommend
   this type of investment for your task at hand?
2. Explain why the Treasury bill’s (aka, T-bill)
   return is independent of the state of the overall economy? Do T-bills
   promise a completely risk-free return? Provide your rationale.
3. Why are Alta Ind.’s returns expected to move
   with the economy whereas Repo Men’s are expected to move counter to the
   economy?
4. Calculate the expected return (), the standard
   deviation (?_p), and the coefficient of variation (CV_p)
   for the portfolio profiled in Table 1. Provide your answers with
   calculations.
5. How does the risk of this two-stock portfolio
   compare with the risk of the individual stocks if those stocks were held
   in isolation? In what ways do “portfolio effects” impact how
   investors think about the risk of individual stocks?
6. If you decided to hold a simple one-stock
   portfolio, and consequently were exposed to more risk than diversified
   investors, could you expect to be compensated for all of your risk; that
   is, could you earn a risk premium on that part of your risk that you could
   have eliminated by diversifying? Explain.
7. Describe how market risk is measured for
   individual securities. How are beta coefficients calculated? Calculate
   beta using the following historical returns for the stock market and for
   another company, P.Q. Unlimited (PQU) as per Table 2 on the attached
   resource, “Topic 5 Assignment Graphic Tables.” Note: Use
   the Excel formula function to calculate beta and interpret your results.
8. Write out the Security Market Line (SML)
   equation and use it to calculate the required rate of return on each
   alternative. Compare the expected rates of return with the required rates
   of return. How do these perform against your predictions?
9. Does the fact that Repo Men has an expected
   rate of return less than the T-bill rate of return make any sense? Why or
   why not?
10. What would be the market risk and the required
    return of a 50-50 portfolio of Alta Industries and Repo Men? Or of Alta
    Industries and American Foam? Based on your analysis and conclusions,
    which would you recommend to your client?

Prepare this assignment according to
the guidelines found in the APA Style Guide, located in the Student Success
Center. An abstract is not required.