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Question 1: Portfolio riskHow many variance terms and how many different covariance terms do you need to calculate the risk of a 100-share portfolio? Suppose all stocks
Question 1: Portfolio risk
- How many variance terms and how many different covariance terms do you need to calculate the risk of a 100-share portfolio?
- Suppose all stocks had a standard deviation of 30% and a correlation with each other of .4. What is the standard deviation of the returns on a portfolio that has equal holdings in 50 stocks?
- What is the standard deviation of a fully diversified portfolio of such stocks?
Question 2: Certainty equivalents
A project has a forecasted cash flow of $110 in year 1 and $121 in year 2. The interest rate is 5%, the estimated risk premium on the market is 10%, and the project has a beta of .5. If you use a constant risk-adjusted discount rate, what is
- The PV of the project?
- The certainty-equivalent cash flow in year 1 and year 2?
- The ratio of the certainty-equivalent cash flows to the expected cash flows in years 1 and 2?
Question 3: Measuring risk
The following table shows estimates of the risk of two well-known Canadian stocks:
table is attached via Word doc.
- What proportion of each stock's risk was market risk, and what proportion was specific risk?
- What is the variance of TDM Bank? What is the specific variance?
- If the CAPM is correct, what is the expected return on TDM Bank? Assume a risk-free interest rate of 5% and an expected market return of 12%.
- Suppose that next year the market provides a zero return. Knowing this, what return would you expect from TDM Bank?
The total market value of the common stock of the OKF Real Estate Company is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock is currently 1.5 and that the expected risk premium on the market is 6%. The Treasury bill rate is 4%. Assume for simplicity that OKF debt is risk-free and the company does not pay tax.
- What is the required return on OKF stock?
- Estimate the company's cost of capital.
- Suppose the company wants to diversify into the manufacture of rose-colored spectacles. The beta of unleveraged optical manufacturers is 1.2. Estimate the required return on OKF's new venture.
Your paper should be 3 pages in length (excluding cover page and references) and formatted according to the APA format.