Answer for part 2

A Assignment NO 5 RISK AND RETURN-converted.pdf - Adobe Acrobat Reader DC (32-bit) File Edit View Sign Window Help Home Tools Assignment NO 5... * Sign In 1 / 2 80% 8-23 RISK AND RETURN Assume that you recently graduated with a major in finance. You just landed a job as a financial planner with Merrill Finch Inc., a large financial servias 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 in the following table, shown with their probabilities and associated outcomes. (For now, disregard the items at the bottom of the data; you will fill in the blanks later.) 2-Stock Portfolio T-Bills State of the Economy Recession Below average Average Above average Boom Probability 0.1 02 0.0% 0.4 5.5% 5.5 55 5.5 55 RETURNS ON ALTERNATIVE INVESTMENTS ESTIMATED RATE OF RETURN Market High Tech Collections U.S. Rubber Portfolio (27.09) 27.09 6.096 (17.0%) (7.0) 13.0 (14.0) 3.0) 150 3.0 30.0 (11.0) 41.0 25.0 45.0 (21.0) 26.0 38.0 1.09 9.89 10.596 13.2 18.8 15.2 13.2 1.9 1.4 -0.87 0.88 0.0 10.0 7.5 02 0.1 120 0.0 3.4 0.5 CV b "Note that the estimated retums of US Rubber do not always move in the same direction as the overall economy. For example, when the economy is below average consumers purchase fewer tires 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 new car may choose to wait and Instead purchase new tires for the car they currently own. Under these circumstances, we would expect US, Rubber's stock price to be higher if there was a recession than if the economy was just below average Merrill Finch's economic forecasting staff has developed probability estimates for the state of the economy, and its security analysts have developed a sophisticated computer program, which was used to estimate the rate of return on each alternative under each state of the economy. High Tech Inc. is an electronics firm, Collections Inc collects past-due debts, and US. Rubber manufactures tires and various other rubber and plastics products. Merrill Finch also maintains a "market portfolio" that owns a market-weighted fraction of all publicly traded stocks you can invest in that portfolio and thus obtain average stock market results. Given the situation described, answer the following questions: a. be (1) Why is the T-bill's return independent of the state of the economy? Do T-bills promise a completely risk-free return? Explain. (2) Why are High Tech's returns expected to move with the economy, whereas Collections' are expected to move counter to the economy? (2) How does the riskiness of this two-stock portfolio compare with the riskiness of the individual stocks if they were held in isolation? f. Suppose an investor starts with a portfolio consisting of one randomly selected stock. What would happen: (1) To the riskiness and to the expected return of the portfolio as more randomly selected stocks were added to the portfolio? (2) What is the implication for investors? Draw a graph of the two portfolios to illustrate your answer. 1 A Assignment NO 5 RISK AND RETURN-converted.pdf - Adobe Acrobat Reader DC (32-bit) File Edit View Sign Window Help Home Tools Assignment NO 5... * Sign In 1 / 2 80% 8-23 RISK AND RETURN Assume that you recently graduated with a major in finance. You just landed a job as a financial planner with Merrill Finch Inc., a large financial servias 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 in the following table, shown with their probabilities and associated outcomes. (For now, disregard the items at the bottom of the data; you will fill in the blanks later.) 2-Stock Portfolio T-Bills State of the Economy Recession Below average Average Above average Boom Probability 0.1 02 0.0% 0.4 5.5% 5.5 55 5.5 55 RETURNS ON ALTERNATIVE INVESTMENTS ESTIMATED RATE OF RETURN Market High Tech Collections U.S. Rubber Portfolio (27.09) 27.09 6.096 (17.0%) (7.0) 13.0 (14.0) 3.0) 150 3.0 30.0 (11.0) 41.0 25.0 45.0 (21.0) 26.0 38.0 1.09 9.89 10.596 13.2 18.8 15.2 13.2 1.9 1.4 -0.87 0.88 0.0 10.0 7.5 02 0.1 120 0.0 3.4 0.5 CV b "Note that the estimated retums of US Rubber do not always move in the same direction as the overall economy. For example, when the economy is below average consumers purchase fewer tires 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 new car may choose to wait and Instead purchase new tires for the car they currently own. Under these circumstances, we would expect US, Rubber's stock price to be higher if there was a recession than if the economy was just below average Merrill Finch's economic forecasting staff has developed probability estimates for the state of the economy, and its security analysts have developed a sophisticated computer program, which was used to estimate the rate of return on each alternative under each state of the economy. High Tech Inc. is an electronics firm, Collections Inc collects past-due debts, and US. Rubber manufactures tires and various other rubber and plastics products. Merrill Finch also maintains a "market portfolio" that owns a market-weighted fraction of all publicly traded stocks you can invest in that portfolio and thus obtain average stock market results. Given the situation described, answer the following questions: a. be (1) Why is the T-bill's return independent of the state of the economy? Do T-bills promise a completely risk-free return? Explain. (2) Why are High Tech's returns expected to move with the economy, whereas Collections' are expected to move counter to the economy? (2) How does the riskiness of this two-stock portfolio compare with the riskiness of the individual stocks if they were held in isolation? f. Suppose an investor starts with a portfolio consisting of one randomly selected stock. What would happen: (1) To the riskiness and to the expected return of the portfolio as more randomly selected stocks were added to the portfolio? (2) What is the implication for investors? Draw a graph of the two portfolios to illustrate your answer. 1