D B E e. The risk-free rate on long-term Treasury bonds is 6.04%. Assume that the market risk premium is 5%. What is the expected return on the market? Now use the SML equation to calculate the two companies' required returns. Market risk premium (RPM) - 5.000% Risk-free rate 6.040% Risk-free rate 6.040% 11.040% + + Market risk premium 5.000% 1 Expected retum on market - 2 3 24 5 Required retum 56 07 Goodman: OB Required retum 09 110 111 Landry: 112 Required retum 113 114 115 116 117 118 119t. If you formed a portfolio that consisted of 50% Goodman stock and 50% Landry stock, what would be its 120 beta and its required return? 121 122 The beta of a portfolio is simply a weighted average of the betas of the stocks in the portfolio, so this portfolio's beta 123 would be: 124 125 Portfolio beta- 126 127 g. Suppose an investor wants to include Goodman Industries' stock in his or her portfolio Stocks A, B, and C 128 129 are currently in the portfolio, and their betas are 0.769, 0.985, and 1.423, respectively. Calculate the new 130 portfolio's required return if it consists of 25% of Goodman, 15% of Stock A, 40% of Stock B, and 20% of Stock C 131 132 133 Beta Portfolio Weight 134 Goodman 25% 135 Stock A 0.769 15% 130 Stock B 0.985 40% Build a Model 10 Ma Home Insert Draw Page Layout Formulas Data Review View Tell me x Arial 25 General Paste BIU A92 fx B D 722 The beta of a portfolio is simply a weighted average of the botas of the stocks in the portfolio, so this portfolio's beta 123 would be 124 125 Portfolio beta- 126 127 9. Suppose an investor wants to include Goodman Industries' stock in his or her portfolio Stocks A, B, and C 128 120 are currently in the portfolio, and their betas are 0.769, 0.985, and 1.423, respectively. Calculate the new portfolio's required return if it consists of 25% of Goodman, 15% of Stock A, 40% of Stock B, and 20% of 130 Stock C 131 132 133 Beta Portfolio Weight Goodman 25% 135 Stock A 0.769 15% 136 Stock B 0.985 40% 137 Stock 1.423 20% 138 100% 139 Portfolio Beta- 140 141 Required retum on portfolio Risk-free rate + Market Risk Premium 142 Beta 143 144 145 146 147 148 149 150 151 152 153 154 155 156 167 168 159 160 161 162 163 164 Build a Model 10 MacBoo A92 x v fx B E 6a. Use the data given to calculate annual returns for Goodman, Landry, and the Market Index, and then 7 calculate average returns over the five-year period. (Hint: Remember, returns are calculated by subtracting 8 the beginning price from the ending price to get the capital gain or loss, adding the dividend to the capital 9 gain or loss, and dividing the result by the beginning price. Assume that dividends are already included in the 10 index. Also, you cannot calculate the rate of return for 2014 because you do not have 2013 data.) 11 12 Data as given in the problem are shown below: 13 Goodman Industries Landry Incorporated Market Index 14 Year Stock Price Dividend Stock Price Dividend Includes Divs. 15 2019 $25.88 $1.73 $73.13 $4.50 17,495.97 16 2018 $22.13 $1.59 $78.45 $4.35 13.178.55 17 2017 $24.75 $1.50 $73.13 $4.13 13,019.97 18 2016 $16.13 $1.43 $85.88 $3.75 9,651.05 19 2015 $17.06 $1.35 $90.00 $3.38 8,403.42 20 2014 $11.44 $1.28 $83.63 $3.00 7,058.96 21 22 We now calculate the rates of retum for the two companies and the index: 23 24 Goodman Landry Index 25 2019 24.8% -1.0% 32.8% 26 2018 4.2% 13.2% 1.2% 27 2017 62.7% -10.0% 34.9% 28 2016 2.9% -0.4% 14.8% 29 2015 60.9% 11.7% 19.0% 30 31 Average 29.4% 2.7% 20.6% 32 33 Note: To get the average, you could get the column sum and divide by 5, but you could also use the function 34 wizard, fx. Click fx, then statistical, then Average, and then use the mouse to select the proper range. Do this for 35 Goodman and then copy the cell for the other items 36 37 b. Calculate the standard deviation of the returns for Goodman, Landry, and the Market Index. (Hint: Use the 38 sample standard deviation formula given in the chapter, which corresponds to the STDEV function in Excel) 39 40 Use the function wizard to calculate the standard deviations 41 42 Goodman Landry Index 43 Standard deviation of retums 31.4% 9.7% 13.8% 45 46 47 6. Construct a scatter diagram graph that shows Goodman's and Landry returns on the vertical axis and the Build a Model 10 osle B 92 Xv fx A D E F c. Construct a scatter diagram graph that shows Goodman's and Landry' returns on the vertical axis and the Market Index's returns on the horizontal axis. It is easiest to make scatter diagrams with a data set that has the X-axis variable in the left column 1 so we reformat the retums data calculated above and show it just below. 2 3 Year Index Goodman Landry 2019 32.8% 24.8% -1.0% 55 2018 1.2% 4.2% 13.2% 56 2017 34.9% 62.7% -10.0% 57 2016 14.8% 2.9% -0.4% 58 2015 19.0% 60.9% 11.7% 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 To make the graph, we first selected the range with the retums and the column heads, then clicked the chart wizard, 77 then choose the scatter diagram without connected lines. That gave us the data points. We then used the drawing 78 toolbar to make free-hand (by eye") regression lines, and changed the lines color and weights to match the dots. 79 80 its clear that Goodman moves with the market and Landry moves counter to the market. So goodman has a positive beta 81 and Laundry a negative one. 82 83 d. Estimate Goodman's and Landry's betas as the slopes of regression lines with stock returns on the 84 vertical axis ly-axis) and market return on the horizontal axis (x-axis). (Hint: use Excel's SLOPE function) 85 Are these belas consistent with your graph? 86 87 Goodman's beta 88 Landry beta -0.50 1.54 89 Build a Model 6 10