Question 5 a. Consider an economy with two types of firms, S and I. S firms...
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Question 5 a. Consider an economy with two types of firms, S and I. S firms always move exactly together, but I firms move independently of each other. For both types of firms there is a 60% probability that the firm will have a 20% return and a 40% probability that the firm will have a -30% return. i. What are the expected returns and standard deviation for firms S and I? (4 marks) ii. Should a risk averse investor be indifferent between a portfolio of 20 firms of type S and another portfolio of 20 firms of type I? (2 marks) b. Comment on the accuracy of the statement that as we put more stocks in a portfolio, its risk gets eliminated to zero. (3 marks) c. UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart? (3 marks) . d. Why should an investor invest in a negative-beta stock knowing that it will have an expected return lower than the risk-free rate? (3 marks) Question 5 a. Consider an economy with two types of firms, S and I. S firms always move exactly together, but I firms move independently of each other. For both types of firms there is a 60% probability that the firm will have a 20% return and a 40% probability that the firm will have a -30% return. i. What are the expected returns and standard deviation for firms S and I? (4 marks) ii. Should a risk averse investor be indifferent between a portfolio of 20 firms of type S and another portfolio of 20 firms of type I? (2 marks) b. Comment on the accuracy of the statement that as we put more stocks in a portfolio, its risk gets eliminated to zero. (3 marks) c. UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart? (3 marks) . d. Why should an investor invest in a negative-beta stock knowing that it will have an expected return lower than the risk-free rate? (3 marks)
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