1. Suppose that Citigroup (C) has an expected return of 14%, while McDonald's (MCD) has an expected return of 8%. Find the expected return of a portfolio consisting of 75% C and 25% MCD. Show work and do not round.
2. This graph shows the annual returns for stocks A, B, and C over a seven year time period. Separately, the three stocks have about the same expected returns and standard deviations.
a. Are stocks A and B positively correlated, negatively correlated, or not correlated? Explain.
b. If your portfolio currently consists only of Stock A, would the addition of stock B cause risk reduction? Explain, using the appropriate terminology.
c. Are stocks A and C positively correlated, negatively correlated, or not correlated? Explain.
d. If your portfolio currently consists only of Stock A, would the addition of stock C cause risk reduction? Explain, using the appropriate terminology.
3. Interpret the betas shown by determining what we expect to happen to the stocks given the described market movement. Note that the last column is asking about a loss. Express your answer as a positive whole percent along with the word "gain" or "loss." (Example: 5% gain).
Stock (Symbol) Beta Expected return if market gains 10% Expected return if market loses 5%
General Mills (GIS) 0.20
Overstock (OSTK) 2.60
Emergent Bio-solutions (EBS) -0.40
4. Using the betas given above, find the beta of a portfolio consisting of 50% GIS stock, 30% OSTK stock, and 20% EBS stock. Show work.
5. You are going to hold a stock for one year. Over the year, you expect the overall market to return 12%, and you expect the yield on the 3-month treasury bill to be 2%. Use the CAPM equationto answer the following questions.
a. The beta of United Parcel Service (UPS) is about 0.8. What must you require regarding the return on United Parcel Service in order to justify the risk of owning it over the next year? Give a numerical answer and show work.
b. The beta of Apple (AAPL) is about 1.5. What must you require regarding the return on Apple in order to justify the risk of owning it over the next year? Give a numerical answer and show work.
c. Suppose that you expect to earn an internal rate of return of 15% on AAPL stock. According to the guidelines in the text, would this be an acceptable investment? Explain.
6. An investor has the following portfolios available:
Portfolio X, with expected return 8% and standard deviation 9%
Portfolio Y, with expected return 8% and standard deviation 12%
Portfolio Z, with expected return 10% and standard deviation 12%
a. We can say for sure that Portfolio X is superior (efficient) compared to Portfolio Y. Explain how we know.
b. Can we make the same sort of definite choice between Portfolio Y and Portfolio Z? Explain.
c. Can we make the same sort of definite choice between Portfolio X and Portfolio Z? Explain.