1. The potential return on the Butterfield Corp. stock has the following distrib
ID: 2739165 • Letter: 1
Question
1. The potential return on the Butterfield Corp. stock has the following distribution:
Prob. Return
.05 -15%
.10 -5%
.15 0%
.20 8%
.25 12%
.15 20%
.10 32%
Calculate the expected return and standard deviation for Butterfield stock. (5 pts.)
2. If you have $3,000 invested in the ABC Corp., $5,000 in the XYZ Corp, $8,000 in the 123 Corp. and $12,000 in the DoReMi Corp., and their expected returns and betas are as follows:
Company beta expected return
ABC 1.8 18%
XYZ 0.6 8%
123 0.95 11%
DoReMi 0.45 6.5%
Calculate the expected return and beta for your portfolio. If the risk free rate is 3.7% and the required return on the market portfolio is 10.4%, what is the required return on the portfolio? Do you think that this portfolio offers a reasonable risk/return tradeoff? Why or why not? (5 pts)
Explanation / Answer
1) Butterfield Corp stock: Probability Return p*r d=r-Er d^2 p*d^2 0.05 (0.15) (0.0075) (0.2455) 0.06027 0.00301 0.10 (0.05) (0.0050) (0.1455) 0.02117 0.00212 0.15 - - (0.0955) 0.00912 0.00137 0.20 0.08 0.0160 (0.0155) 0.00024 0.00005 0.25 0.12 0.0300 0.0245 0.00060 0.00015 0.15 0.20 0.0300 0.1045 0.01092 0.00164 0.10 0.32 0.0320 0.2245 0.05040 0.00504 0.0955 0.01337 Expected return = 0.0955 = 9.55% Standard deviation = 0.01337 = 11.56% 2) Company Beta Expected Amount Weight Return-% Invested R*Wt Beta * Wt ABC 1.80 18 3000 0.1071 1.93 0.19 XYZ 0.60 8 5000 0.1786 1.43 0.11 123 0.95 11 8000 0.2857 3.14 0.27 DoReMi 0.45 6.5 12000 0.4286 2.79 0.19 28000 1.0000 9.29 0.76 Expected return of the portfolio = 9.29% Beta of the portfolio = 0.76 Required return on the portfolio as per CAPM = 3.7 + 0.76*(10.4-3.70) = 8.79 Yes, this portfolio provides a reasonable risk-return tradeoff as its expected return of 9.29% is more than that mandated by CAPM.
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