Part 2. Evaluating Risk and Return Using a Calculator. Assume that Walmart\'s st

Question

Part 2. Evaluating Risk and Return Using a Calculator. Assume that Walmart's stock (W) has a 10% expected return, a beta coefficient of 0.9, and a 35% standard deviation of expected returns. Further assume that Target's stock (T) has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. Show your work in all calculations.

Question 1: Calculate each stock's coefficient of variation (CV). Check figure: CV of T = 2.0.

Question 2: Which stock would be considered riskier assuming that the stock will be held in a portfolio (this would be a diversified investment) rather than as a stand-alone investment? Explain your answer.

Question 3: Calculate each stock's required rate of return using the Security Market Line equation. Check figure: required return for W = 10.5%.

Question 4: On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? Explain your answer.

Question 5: Assume that your portfolio consists of $7,500 invested in stock W and $2,500 invested in stock T. Determine the required return of your portfolio. Hint: calculate the beta of the portfolio first. Check figure: bp = 0.975 and rp = 10.875%.

Explanation / Answer

Question 1: Calculate each stock's coefficient of variation (CV). Check figure: CV of T = 2.0.

CoV = S.D/Mean

W = 35%/10% = 3.5

T = 25%/12.5% = 2

Question 2: Which stock would be considered riskier assuming that the stock will be held in a portfolio (this would be a diversified investment) rather than as a stand-alone investment? Explain your answer.

Stock having higher COV would be riskier i.e W stock

Question 3: Calculate each stock's required rate of return using the Security Market Line equation. Check figure: required return for W = 10.5%.

SML = Rf+Beta(Risk premium of market)

W = 6%+0.9(5%) = 10.5%

T = 6%+1.2(5%) = 12%

Question 4: On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? Explain your answer.

Stock T would be more attractive as it has higher return than required return of 12%

Question 5: Assume that your portfolio consists of $7,500 invested in stock W and $2,500 invested in stock T. Determine the required return of your portfolio. Hint: calculate the beta of the portfolio first. Check figure: bp = 0.975 and rp = 10.875%.

Beta of portfolio = Weight of W*beta of W+ Weight of T*beta of T

Bp = 0.75*0.9 + 0.25*1.2 = 0.975

Rp = 6%+0.975(5%) = 10.875

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