(1) Write out the Security Market Line (SML) equation, use it to calculate the required rate of...
Question:
(1) Write out the Security Market Line (SML) equation, use it to calculate the required rate of return on each alternative, and then graph the relationship between the expected and required rates of return.
(2) How do the expected rates of return compare with the required rates of return?
(3) Does the fact that Repo Men has an expected return that is less than the T-bill rate make any sense
(4) What would be the market risk and the required return of a 50-50 portfolio of Alta Industries and Repo Men? Of Alta Industries and American Foam?
Assume that you recently graduated with a major in finance, and you just landed a job as a financial planner with Barney Smith Inc., a large financial services corporation. Your first assignment is to invest $100,000 for a client. Because the funds are to be invested in a business at the end of 1 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 the table with their probabilities and associated outcomes. (Disregard for now the items at the bottom of the data; you will fill in the blanks later.) 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 rare of return on each alternative under each state of the economy. Alta Industries is an electronics firm; Repo Men Inc. collects past-due debts; and American Foam manufactures mattresses and various other foam products. Barney Smith also maintains an "index fund" that 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 followingquestions.
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The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...
Step by Step Answer:
1 Here is the SML equation r i r rf r m r rf b i If we use the tbill yield as a proxy for the riskfree rate then r RF 8 Further our estimate of r m m ...View the full answer
