Discuss the below:
Q1: Risk and Return. True or false? Explain or qualify as necessary.
a. The expected rate of return on an investment with a beta of 2 is twice as high as the expected rate of return of the market portfolio.
b. The contribution of a stock to the risk of a diversified portfolio depends on the market risk of the stock.
c. If a stock's expected rate of return plots below the security market line, it is underpriced.
d. A diversified portfolio with a beta of 2 is twice as volatile as the market portfolio.
e. An undiversified portfolio with a beta of 2 is twice as volatile as the market portfolio.
Q2: Scenario Analysis. Consider the following scenario analysis:
|
|
|
Rate of Return |
|
Scenario |
Probability |
Stocks |
Bonds |
|
Recession |
20.0% |
-5.0% |
14.0% |
|
Normal economy |
60.0% |
15.0% |
8.0% |
|
Boom |
20.0% |
25.0% |
4.0% |
a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?
b. Calculate the expected rate of return and standard deviation for each investment.
|
|
Stocks |
|
|
Bonds |
|
|
Expected return |
FORMULA |
|
|
FORMULA |
|
|
Variance |
FORMULA |
|
|
FORMULA |
|
|
Standard Deviation |
FORMULA |
|
|
FORMULA |
|
c. Which investment would you prefer?