Your investment strategy is to maximize expected return but with a risk level (s
ID: 2756969 • Letter: Y
Question
Your investment strategy is to maximize expected return but with a risk level (standard deviation) that does not exceed 15%. Since you are a CAPM believer, you hold a combination of the market portfolio and risk free asset. The market expected return in 10% with a standard deviation of 20% and the risk free rate is 3%.
(A) What portfolio do you hold?
NASA has just announced that it not only found water on MARS but it also plans to open a resort on MARS named “MARS for Life”. NASA wishes to sell the new venture to investors in an initial public offering (IPO). An analyst estimates expected profits (Revenues – Expenses) would be $1B one year from now. The analysts mention that these are the expected profits and the risk (standard deviation) of this venture is 30% and the correlation with the market is 0.2. For simplicity we assume that this is a 1 year project where all revenues and expenses occur 1 year from now.
Q: 1 In the public offering NASA plans to sell 50M shares. What is the maximal share price at which you will invest in the new venture?
Q: 2 Suppose that the price for “MARS for Life” is lower than your answer in Q: 1. How would your answer to Part (A) change? What portfolio would you hold?
PLEASE SHOW FULL CALCULATIONS AND OFFER EXPLANATION OF ALL CASES OF ABOUT 300 WORDS
Explanation / Answer
A) Expecetd return with a risk level (standard deviation) that does not exceed 15% as per CAPM model
Rp= Rf + beta ( market return- risk free return)
Rf = risk free rat of return
Rp= Expected return
= 3% + 1.5(10-3)
Expecetd return = 10.53%
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