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Every investment carries the expectation of a return, which is represented as the additional percentage rate that we expect to obtain when investing our money
Every investment carries the expectation of a return, which is represented as the additional percentage rate that we expect to obtain when investing our money in a financial instrument. It is essential to understand that a higher percentage rate generally implies a greater risk of losing the investment made. As a financial manager, it is imperative to review the required return on stocks before making any investment move. In the next task, you must do the following:
- Carefully study the exercises and concepts in Chapter 8: "Risk and Rates of Return" of the textbook (pp. 298-306) to perform an exercise on calculating the required rate of return.
- Take into account the following information: Assume that there are two types of actions X (beta 0.9) and Y (beta 1.5), and evaluate each of the following scenarios separately:
- The risk free rate is 3% and the risk premium is 5.5.
- The risk free rate is 3% and the risk premium is 7.5.
- Inflation rises 2% and the risk premium is 7.5.
- Then, perform the necessary calculations to determine the following:
- Desired return for X in each of the scenarios (A, B and C). Be sure to clearly show your calculations and the process for obtaining each result. For each scenario , explain the result obtained and the effect of beta on the process.
- Desired return for Y in each of the scenarios (A, B and C). Be sure to clearly show your calculations and the process for obtaining each result. For each scenario , explain the result obtained and the effect of beta on the process.
- If your company is risk adverse , what would be your recommendation regarding investing in:
- actions X under the scenarios presented (A, B and C).
- actions Y under the scenarios presented (A, B and C).
- If your company likes to take risks , what would be your recommendation regarding investing in:
- actions X under the scenarios presented (A, B and C).
- actions Y under the scenarios presented (A, B and C).
Step by Step Solution
There are 3 Steps involved in it
Step: 1
To calculate the required rate of return for actions X and Y in each scenario well use the Capital Asset Pricing Model CAPM The formula for CAPM is as ...Get Instant Access to Expert-Tailored Solutions
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Step: 2
Step: 3
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