BUA321 Chapter 8 Class notes
1) If you are thinking of investing in a stock, what things would you investigate?
CF
Risk
News (company, industry, economy)
2) What is inside trading?
Trading on info that no one else has.
Who has this info?
Why is it a problem?
3) What does this mean: “There is no such thing as a free lunch”?
All benefits and services have a price tag.
Think of options in a car.
If a security has a benefit to the owner, what happens to their return? Price?
What about the issuing company?
4) Calculate the holding period return for TAP. Dividends totaled $3.90.
TAP closing prices
Date
Close
4/1/2013
52.65
4/22/2010
44.36
a. What is the difference between Return and HPR?
Which is more important?
Return does not assume any compounding or the time value of
money.
HPR implies that calculation with compounding
Your invest grew from $10 to $15.
Return = 50%
But what if it took 10 years?
4.14%
Which is better?
5) What does history tell us about stock returns?
How many negative returns are there compared to positive?
Double digit?
What does this mean for you?
6) How would you describe Risk?
Uncertainty
Volatility
Changing
Future
Unexpected
7) If you purchased a stock for $37 last year and this year it is worth $45. What was the
return?
8) Complete the following table:
i.
Enter your company’s current price.
ii. Choose a percent change for each condition. (what do you think the return will be
for this consumer based company?)
iii. Calculate predicted price and return
iv. Assign a probability (teacher assigns this)
$___
price
Next year
Change %
price
Predicted Probability
price
Good economy 15%
Average
Economy
5%
Bad Economy
-4%
9) Calculate the statistics for this asset.(use standalone risk)
Include the predicted prices to get the expected price. What is the HPR?
Record the return information below.
10) Repeat the process above with the following two stocks. Record the statistics of these
two stocks below. Create 3 portfolios per the table.
Stock 2
-9%
15%
20%
Asset
1
2
3
Port1
1 (.65)
2 (.35)
Port2
2 (.45)
3 (.55)
Port3
1 (.80)
3 (.20)
Port4
1 (.45)
2 (.25)
3 (.30)
Expected return
Stock 3
8%
4%
2%
Standard Deviation
CV
11) Combine 2 assets into a portfolio. Insert the picture of the efficient frontier of the
portfolio.
i.
What is an efficient portfolio
You cannot find a portfolio with a larger return at a given level of risk.
Maximize returns given risk.
This is a group of the best possible investments?
Which one would you like.
Provide the bullet curve and derive the efficient frontier.
12) What can you say about the information in the following tables:
Higher returns have higher risk
Small companies have highest returns and highest risk
Where do you think medium sized stocks would be?
13) What is meant by “Do Not Put All Your Eggs in One Basket”
Describe the concept of 100 baskets
What is the chance that all the baskets get stepped on?
14) Calculate the return on the following portfolio: (use portfolio beta and return worksheet)
Asset
$ invested
Return
A
5,000
9%
B
7,000
12%
C
1,000
6%
D
10,000
19%
E
1,500
4%
F
2,000
7%
G
7,000
10%
15) What does correlation describe?
How two things seem to act alike.
Positive / negative
Maximum +1.0
minimum -1.0
16) What does CAPM describe?
The relationship between the returns of a stock and the returns of a stock market?
Market risk
Straight line relationship
17) What things create diversifiable risk? Non-diversifiable risk?
Total risk = diversifiable risk + non-diversifiable risk
Company specific
market risk
Lawsuits, strikes
inflation, economic conditions
What is the formula for risk? (standard deviation)
How does correlation reflect the above formula?
18) What is beta?
http://www.youtube.com/watch?feature=player_detailpage&v=etlv7qTQUSY
Measure of sensitivity
Measures market risk
SML?
19) What is the beta of the following portfolio? (use portfolio beta and return)
Asset
$ invested
Return
A
5,000
9%
1.25
B
7,000
12%
1.75
C
1,000
6%
.54
D
10,000
19%
2.79
E
1,500
4%
.32
F
2,000
7%
.75
G
7,000
10%
1.95
20) Use the beta of the above portfolio to calculate the expected return of a portfolio. Use
the 30 year Treasury yield for the risk free rate and 12% for the average return of the
market.
What is market risk premium?
21) Group activity (group of 3)
i.
Complete the following exercise
Use the same market and RF returns
i. You are given $100,000 to invest in your groups stocks
ii. Find the betas for your companies and input into the portfolio beta and
return worksheet
iii. Decide how much to invest in each asset
iv. Calculate the expected returns and betas for this portfolio
Numbers investors should know.
http://youtu.be/SXLkP4_gX1Y
Offline Homework (38 points) _______
BUA321 Chapter 08 Web exercise
1) calculate the statistics for the following investments:
stand alone risk(12)
event
Pr
rx
ry
rz
very good
.30
12
-8
8
good
.20
8
-3
8
Avg
.25
2
6
8
Bad
.15
-5
10
8
Very Bad
.10
-10
19
8
Asset X
Asset Y
Asset Z
E( R)
3.95
1.9
8.0
Variance
.55
.77
0
Standard
deviation
7.43
8.8
0
CV
1.88
4.63
--
2) For the above assets, create the portfolios below (use stand alone risk)
a)
40% X, 35% Y, 25% Z
b)
60% X, 40% Y
c)
35% Y, 65% Z
Portfolio a
Portfolio b
Portfolio c
E( R)
4.25
3.13
5.87
Variance
0
.01
.09
Standard
deviation
.48
1.11
3.08
CV
.11
.36
.53
(12)
3) Calculate the portfolio statistics for the following assets: (use portfolio risk and return) (21)
weight
return
variance
beta
XYZ
.35
12
7
1.23
DEF
.25
9
12
1.98
HIJ
.40
15
20
2.98
correlation
XYZ
DEF
HIJ
XYZ
DEF
HIJ
1.0
-.25
.75
1.0
.45
1.0
Portfolio A
Portfolio B
(.35, .25, .40) (.45, .25, .30)
Portfolio C
(.10, .75, .15)
E( R)
12.45
10.2
Variance
8.29
6.89
8.76
Standard
deviation
28.79
26.26
29.6
Beta
2.12
1.94
2.06
CV
2.31
2.16
2.90
12.15
4) If the risk free rate of return is 3.75% and the stock market averages 12%,
what is the expected return on the portfolios using the SML?
A
21.24%
B
19.76%
C 20.75%