FIN 361 Fall 2023 Problem Set 2 Question 3 [15 points] Nutella Inc. has expected returns of 10% and volatility of 5%. Kale Inc. has expected return 4% and volatility 25%. Nutella and Kale have a correlation of -.5. The following table shows portfolio weights and expected returns and volatiles for the various portfolios. Weight Nutella Weight Broccoli | E[R_p] SD[R_p] 90% 10% | 80% | 20% 8.8% 5.6% | 50% | 50% 7% 12.1% | 25% | 75% | 0% | 100% 4% 25% a. Fill in the missing information in the table above (expected return and volatility for the respective portfolios). b. Plot the efficient frontier for the Nutella and Kale portfolios. Which of the portfolio bundles in the table, if any, are on the efficient frontier? Which portfolio in the table offers the best Sharpe Ratio? d. How does the volatility of the highest Sharpe Ratio portfolio compare to the volatility of the all Nutella portfolio? Why is this the case? n Note: Show your work. FIN 361 Fall 2023 Problem Set 2 Question 4 [15 points] Intel has BBB+ rated, 10-year bonds outstanding with a yield to maturity of 5.5%. Risk-free treasury bonds with similar maturity have a yield of 4.1%. Suppose the market risk premium is 8% and you believe Intel's bonds have a beta of 0.08. The expected loss rate of these bonds in the event of default is 55%. a) What is the expected return (i.e., cost of debt capital) of Intel's debt? b) Given your answer in part (a), what annual probability of default (p) would be consistent with the yield to maturity of these bonds? c) Ten years later, Intel's debt has been downgraded to CCC-. The yield to maturity on its 10-year outstanding bonds is now 11%. Comparable treasury bonds now have yield of 2%. Estimate Intel's new debt beta. What is the expected return on Intel's debt now? Which probability of default (p) would you estimate now? (Hint: use lecture notes from Lecture 12 to estimate Intel's new debt beta and then assume that the market risk premium and the loss given default have not changed from parts (a) and (b).)