QUESTION

# 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

1. How      many variance terms and how many different covariance terms do you need to      calculate the risk of a 100-share portfolio?
2. 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?
3. 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

1. The PV      of the project?
2. The      certainty-equivalent cash flow in year 1 and year 2?
3. 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.

1. What      proportion of each stock's risk was market risk, and what proportion was      specific risk?
2. What      is the variance of TDM Bank? What is the specific variance?
3. 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%.
4. Suppose      that next year the market provides a zero return. Knowing this, what      return would you expect from TDM Bank?

Question 4:

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.

1. What      is the required return on OKF stock?
2. Estimate      the company's cost of capital.
3. 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.