Risk and Return Exam

Show work for all problems:

1. The following probability distribution of expected returns have been determined for Benko Corporation  

Probability         Expected Returns (Outcomes) 

.30                     12%

.40                     15%

.20                     25%

.10                     0%

First calculate the expected rate of return, r with ^

Now calculate the standard deviation

Then calculate the coefficient of variation

2. On a normal bell curve, 68.26% of the time, the actual returns will fall within +1 and -1 deviations of the expected rate of return, r with ^. Therefore, Benko's actual rate of return should be no greater than _____% an no less than ____% 68.25% of the time.  That is, within one deviation of the expected rate of return.

Use the letter in front of the statement to answer the questions that follow. Read all the options first. The letter may be used to answer more than one qustion.

A. It increases by 3%

B. it decreases by 3%

C. It increases, but not proportionately

D. It decreases, but not proportionately

E. No change, remains the same

F. The SML shifts upwad, but the slope remains the same

G. The SML shifts downward, but the slope remains the same

H. The SML pivots upward, and the slope becomes steeper

I. The SML pivots downward, and the slope becomes flatter.

3. Assume that inflation is expected to increase by 3% this year:

   1.___what would happen to the risk free rate, rtf

   2.___what would happen to the market reate, rm

   3.___what would hapen to the required state, r

   4.___wht would happen to the slope of the SML

4. Now assume that inflation will not increase but investors become more averse to risk, thus requiring an additional 33% return on their investments.

   1.___what would happen to the risk free rate, rtf

   2.___what would happen to the market reate, rm

   3.___what would hapen to the required state, r

   4.___wht would happen to the slope of the SML

5. There are three investment opportunities to consider. The forecasted risk-free rate is 9%, and the expected market rate is 13%. What is the required rate of return, r, for each of the following scenarios?

Assume investment A has a beta of .8

Assume investment B has a beta of 1.5

Assume investment C has a beta of 2.0

Which is the least risky inestment?___ Which is the most risky investment?___

Calculate "r" the rquired rate of return for each of the following.

6. Assume beta is 1.3 for this and the next two problems, the risk-free rate is 6.5%, and market risk is 10.5%.

7. Now assume the risk-free rate increases to 8% because inflation is expected to increase next year.

What will happen to the slope of the SML? Steeper, flatter, or remains constant?  Pivots up, pivots down, shifts up, or shifts down?

9. Now assume the investors are more averse to risk in the market and require an additional 1%. The risk-free rat eis 6.5%.

What will happen to the slope of the SML? Steeper, flatter, or remains constant?  Pivots up, pivots down, shifts up, or shifts down?

10. Based on what you know about risk, deermine which of the following exposes the investor to more risk. First calculate the coeficient of variation for each. Which is the riskiest? Explain.

Company A has an expected rate of return of 12% and a standard deviation of 3%

Company B has an expected rate of return of 8% and a standard deviation of 2%.

Company C has an expected rate of return of 20% and a standard deviation of 5%

11. If the correlation coefficient, p, is equal to +1.0, perfectly positively correlated, has diversification worked? Yes or No. Is this a risky portfolio? Yes or No

12. If the correlation coefficient, p,. is equal to -1.0, perfectly negative correlated, has diversification worked? Yes or No. Is this a risky portfolio? Yes or No

13. Suppose you are the manager of a $10,000,000 investment fund. The fund consists of 4 stocks with the following investments and beta coefficients:

Stock A - $3,000,000 - beta 1.5

Stock B - $2,000,000 - beta 1.0

Stock C - $4,000,000 - beta 0.5

Stock D - $1,000,000 - beta 2.0

14. If the market's required rate of return (rm) is 13% and the risk-free rate (rRF) is 6%, what is the funds required rate of return, r? You must first find the beta for the portfolio. Then use it to calculate4 the required rate of return using the SML equation.