Part 2. Evaluating Risk and Return Using a Calculator. Assume that Walmart\'s st
ID: 2736457 • Letter: P
Question
Part 2. Evaluating Risk and Return Using a Calculator. Assume that Walmart's stock (W) has a 10% expected return, a beta coefficient of 0.9, and a 35% standard deviation of expected returns. Further assume that Target's stock (T) has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. Show your work in all calculations.
Question 1: Calculate each stock's coefficient of variation (CV). Check figure: CV of T = 2.0.
Question 2: Which stock would be considered riskier assuming that the stock will be held in a portfolio (this would be a diversified investment) rather than as a stand-alone investment? Explain your answer.
Question 3: Calculate each stock's required rate of return using the Security Market Line equation. Check figure: required return for W = 10.5%.
Question 4: On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? Explain your answer.
Question 5: Assume that your portfolio consists of $7,500 invested in stock W and $2,500 invested in stock T. Determine the required return of your portfolio. Hint: calculate the beta of the portfolio first. Check figure: bp = 0.975 and rp = 10.875%.
Explanation / Answer
Question 1: Calculate each stock's coefficient of variation (CV). Check figure: CV of T = 2.0.
CoV = S.D/Mean
W = 35%/10% = 3.5
T = 25%/12.5% = 2
Question 2: Which stock would be considered riskier assuming that the stock will be held in a portfolio (this would be a diversified investment) rather than as a stand-alone investment? Explain your answer.
Stock having higher COV would be riskier i.e W stock
Question 3: Calculate each stock's required rate of return using the Security Market Line equation. Check figure: required return for W = 10.5%.
SML = Rf+Beta(Risk premium of market)
W = 6%+0.9(5%) = 10.5%
T = 6%+1.2(5%) = 12%
Question 4: On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? Explain your answer.
Stock T would be more attractive as it has higher return than required return of 12%
Question 5: Assume that your portfolio consists of $7,500 invested in stock W and $2,500 invested in stock T. Determine the required return of your portfolio. Hint: calculate the beta of the portfolio first. Check figure: bp = 0.975 and rp = 10.875%.
Beta of portfolio = Weight of W*beta of W+ Weight of T*beta of T
Bp = 0.75*0.9 + 0.25*1.2 = 0.975
Rp = 6%+0.975(5%) = 10.875