Chapter 6 Mini-Case: Risk, Return, and the Capital Assets Pricing Model Review t

Question

Chapter 6 Mini-Case: Risk, Return, and the Capital Assets Pricing Model Review the mini-case in Chapter 6 of your text and respond to the following:

***MUST SHOW ALL WORK***

Andrea Corbridge is considering forming a portfolio consisting of Kalama Corp. and Adelphia Technologies. The two corporations have a correlation of -0.1789, and their expected returns and standard deviations are as follows:

Kalama Corp. Adelphia Technologies Expected return (%) 14.86 23.11 Standard Deviation (%) 23.36 31.89

1. Calculate the frontier for all possible investment combinations of Kalama Corp. and Adelphia Technologies (from 0% to 100%, in 1% increments). Determine the optimal risky portfolio if the risk-free rate is 3%.

2. Andrea has $50,000 and wants to earn a 19% expected return on her investment. Describe the optimal manner in which to structure her portfolio-both in dollar amounts and in weights relative to her $50,000-based on the preceding information.

3. Andrea is also seriously considering buying some stock in Medford Barnett Corporation (MBC). The stock prices of MBC and the S&P for the past 25 months are tabulated below. Andrea estimates that MBC will earn a 14% return during the next year, and she expects the market to earn a 12% return during the same time period. In addition, she expects the relationship exhibited between the S&P and MBC to remain as it has in the past. Assuming that Andrea would be pulling MBC into a fully diversified portfolio, explain if buying the MBC shares a good decision.

Month S&P MBC
1 1,198.41 58.04
2 1,228.81 65.36
3 1,220.33 48.48
4 1,234.18 53.32
5 1,191.33 57.59
6 1,191.50 49.23
7 1,156.85 55.57
8 1,180.59 50.99
9 1,203.60 64.10
10 1,181.27 50.45
11 1,211.92 50.65
12 1,173.82 51.23
13 1,130.20 46.68
14 1,114.58 51.09
15 1,104.24 50.75
16 1,101.72 59.80
17 1,140.84 52.78
18 1,120.68 49.22
19 1,107.30 53.47
20 1,126.21 49.26
21 1,144.94 48.55
22 1,131.13 61.32
23 1,111.92 48.06
24 1,058.20 58.88
25 1,050.71 46.19

Graham, John; Smart, Scott B.; Megginson, William L (2009-09-28). Corporate Finance: Linking Theory to What Companies Do (Available Titles CourseMate) (Page 227). Cengage Textbook. Kindle Edition.

Explanation / Answer

Weights Expected Return Standard Deviation 0 1 0.2311 0.3189 0.000 0.564712 0.01 0.99 0.230275 0.318047 0.000 0.563723 0.02 0.98 0.22945 0.317194 -0.001 0.562736 0.03 0.97 0.228625 0.316341 -0.001 0.561752 0.04 0.96 0.2278 0.315488 -0.001 0.560771 0.05 0.95 0.226975 0.314635 -0.001 0.559794 0.06 0.94 0.22615 0.313782 -0.002 0.558819 0.07 0.93 0.225325 0.312929 -0.002 0.557847 0.08 0.92 0.2245 0.312076 -0.002 0.556879 0.09 0.91 0.223675 0.311223 -0.002 0.555914 0.1 0.9 0.22285 0.31037 -0.002 0.554951 0.11 0.89 0.222025 0.309517 -0.003 0.553992 0.12 0.88 0.2212 0.308664 -0.003 0.553036 0.13 0.87 0.220375 0.307811 -0.003 0.552084 0.14 0.86 0.21955 0.306958 -0.003 0.551134 0.15 0.85 0.218725 0.306105 -0.003 0.550188 0.16 0.84 0.2179 0.305252 -0.004 0.549245 0.17 0.83 0.217075 0.304399 -0.004 0.548305 0.18 0.82 0.21625 0.303546 -0.004 0.547368 0.19 0.81 0.215425 0.302693 -0.004 0.546435 0.2 0.8 0.2146 0.30184 -0.004 0.545505 0.21 0.79 0.213775 0.300987 -0.004 0.544578 0.22 0.78 0.21295 0.300134 -0.005 0.543654 0.23 0.77 0.212125 0.299281 -0.005 0.542734 0.24 0.76 0.2113 0.298428 -0.005 0.541818 0.25 0.75 0.210475 0.297575 -0.005 0.540904 0.26 0.74 0.20965 0.296722 -0.005 0.539994 0.27 0.73 0.208825 0.295869 -0.005 0.539088 0.28 0.72 0.208 0.295016 -0.005 0.538184 0.29 0.71 0.207175 0.294163 -0.005 0.537285 0.3 0.7 0.20635 0.29331 -0.006 0.536388 0.31 0.69 0.205525 0.292457 -0.006 0.535496 0.32 0.68 0.2047 0.291604 -0.006 0.534606 0.33 0.67 0.203875 0.290751 -0.006 0.533721 0.34 0.66 0.20305 0.289898 -0.006 0.532838 0.35 0.65 0.202225 0.289045 -0.006 0.53196 0.36 0.64 0.2014 0.288192 -0.006 0.531085 0.37 0.63 0.200575 0.287339 -0.006 0.530213 0.38 0.62 0.19975 0.286486 -0.006 0.529345 0.39 0.61 0.198925 0.285633 -0.006 0.528481 0.4 0.6 0.1981 0.28478 -0.006 0.52762 0.41 0.59 0.197275 0.283927 -0.006 0.526763 0.42 0.58 0.19645 0.283074 -0.006 0.52591 0.43 0.57 0.195625 0.282221 -0.007 0.52506 0.44 0.56 0.1948 0.281368 -0.007 0.524214 0.45 0.55 0.193975 0.280515 -0.007 0.523372 0.46 0.54 0.19315 0.279662 -0.007 0.522533 0.47 0.53 0.192325 0.278809 -0.007 0.521699 0.48 0.52 0.1915 0.277956 -0.007 0.520868 0.49 0.51 0.190675 0.277103 -0.007 0.52004 0.5 0.5 0.18985 0.27625 -0.007 0.519217 0.51 0.49 0.189025 0.275397 -0.007 0.518398 0.52 0.48 0.1882 0.274544 -0.007 0.517582 0.53 0.47 0.187375 0.273691 -0.007 0.51677 0.54 0.46 0.18655 0.272838 -0.007 0.515962 0.55 0.45 0.185725 0.271985 -0.007 0.515158 0.56 0.44 0.1849 0.271132 -0.007 0.514358 0.57 0.43 0.184075 0.270279 -0.007 0.513562 0.58 0.42 0.18325 0.269426 -0.006 0.51277 0.59 0.41 0.182425 0.268573 -0.006 0.511982 0.6 0.4 0.1816 0.26772 -0.006 0.511198 0.61 0.39 0.180775 0.266867 -0.006 0.510417 0.62 0.38 0.17995 0.266014 -0.006 0.509641 0.63 0.37 0.179125 0.265161 -0.006 0.508869 0.64 0.36 0.1783 0.264308 -0.006 0.508101 0.65 0.35 0.177475 0.263455 -0.006 0.507337 0.66 0.34 0.17665 0.262602 -0.006 0.506578 0.67 0.33 0.175825 0.261749 -0.006 0.505822 0.68 0.32 0.175 0.260896 -0.006 0.50507 0.69 0.31 0.174175 0.260043 -0.006 0.504323 0.7 0.3 0.17335 0.25919 -0.006 0.50358 0.71 0.29 0.172525 0.258337 -0.005 0.502841 0.72 0.28 0.1717 0.257484 -0.005 0.502106 0.73 0.27 0.170875 0.256631 -0.005 0.501376 0.74 0.26 0.17005 0.255778 -0.005 0.500649 0.75 0.25 0.169225 0.254925 -0.005 0.499927 0.76 0.24 0.1684 0.254072 -0.005 0.49921 0.77 0.23 0.167575 0.253219 -0.005 0.498496 0.78 0.22 0.16675 0.252366 -0.005 0.497787 0.79 0.21 0.165925 0.251513 -0.004 0.497083 0.8 0.2 0.1651 0.25066 -0.004 0.496382 0.81 0.19 0.164275 0.249807 -0.004 0.495686 0.82 0.18 0.16345 0.248954 -0.004 0.494995 0.83 0.17 0.162625 0.248101 -0.004 0.494308 0.84 0.16 0.1618 0.247248 -0.004 0.493625 0.85 0.15 0.160975 0.246395 -0.003 0.492947 0.86 0.14 0.16015 0.245542 -0.003 0.492273 0.87 0.13 0.159325 0.244689 -0.003 0.491604 0.88 0.12 0.1585 0.243836 -0.003 0.490939 0.89 0.11 0.157675 0.242983 -0.003 0.490279 0.9 0.1 0.15685 0.24213 -0.002 0.489623 0.91 0.09 0.156025 0.241277 -0.002 0.488972 0.92 0.08 0.1552 0.240424 -0.002 0.488326 0.93 0.07 0.154375 0.239571 -0.002 0.487684 0.94 0.06 0.15355 0.238718 -0.002 0.487047 0.95 0.05 0.152725 0.237865 -0.001 0.486414 0.96 0.04 0.1519 0.237012 -0.001 0.485786 0.97 0.03 0.151075 0.236159 -0.001 0.485163 0.98 0.02 0.15025 0.235306 -0.001 0.484545 0.99 0.01 0.149425 0.234453 0.000 0.483931 1 0 0.1486 0.2336 0.000 0.483322 Optimal Risky Portfolio-0.4/0.6 If 50000 have to be invested to earn 19% the Portfolio should be as follows $ Kalama Corp 20000 Adelphia Technologies 30000 Buying MBC is not a Good Decision, as its very volatile, It has gone done by 20 Pints in two Months, Adrea should not consider buying it.

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