Question

The risk free rate of return is 1.8% and the expected return on the market portfolio is 8.35%. Given the following possible returns for Lidar Limited and the S&P/TSX Composite Index(found in Table 1.1):

a.Calculate the expected return for Lidar (illustrate your solution using MS Equation Editor).

b.Calculate the expected return, variance and standard deviation for the S&P/TSX Composite Index(illustrate your solution using an embedded Excel Spreadsheet).

c.Using an embedded Excel Spreadsheet, calculate the Covariance and Correlation Coefficient between Lidar’s returns and the market index returns.

d.Calculate the Ex Ante Beta Coefficient for Lidar. Illustrate the formula and your calculations using MS Equation.

e.Is Lidar an aggressive or defensive investment? Explain.

f.Calculate the required rate of return on Lidar stock.

g.Is Lidar over priced, under priced or fairly valued? Explain.

Table 1.1 - Forecast Possible Returns on Lidar Corp. and S&P/TSXPossible Returns on S&P/TSX                                                                    Possible Returns          Composite State                                                  Probability              on Lidar Corp                 Index Economic Boom                           25%                            47%                           18% Moderate Growth                        30%                            23%                           11% Normal                                           25%                            90%                            7% Recession                                       20%                           -45%                           -6%

Answer 1

	Expected Return =Mean Return =SUMof ((Probability)*(Return))
	Variance of Return =Sum of(Probability* (Deviation ^2))
	Deviation =Return -Mean Return
	Standard Deviation of Return =Square Root of Variance of Return
	ANALYSIS OF MARKET RETURN(S&P/TSX)
		p	R1	A1=R1*P	D1=R1-8.35	E1=(D1^2)	F1=p*E1
	State of Economy	Probability	Return of Lidar(%)	Probability*Return(%)	Deviation(%)	Deviation Squared(%%)	Probability*Deviation Squared(%%)
	Boom	0.25	18	4.5	9.65	93.1225	23.280625
	Moderate Growth	0.3	11	3.3	2.65	7.0225	2.10675
	Normal Growth	0.25	7	1.75	-1.35	1.8225	0.455625
	Recession	0.2	-6	-1.2	-14.35	205.9225	41.1845
			SUM	8.35		SUM	67.0275
	Expected Return =Mean return S&P/TSX	8.35	%
	Variance of Return	67.0275	%%
	Standard Deviation of Return =SQRT(67.0275)=	8.19	%
	ANALYSIS OF RETURNS OF LIDAR LIMITED
		p	R2	A2=R2*p	D2=R2-32.15	E2=(D2^2)	F2=p*E2
	State of Economy	Probability	Market Return(%)	Probability*Return(%)	Deviation(%)	Deviation Squared(%%)	Probability*Deviation Squared(%%)
	Boom	0.25	47	11.75	14.85	220.5225	55.130625
	Moderate Growth	0.3	23	6.9	-9.15	83.7225	25.11675
	Normal Growth	0.25	90	22.5	57.85	3346.6225	836.655625
	Recession	0.2	-45	-9	-77.15	5952.1225	1190.4245
			SUM	32.15		SUM	2107.3275
	Expected Return =Mean return of Lidar Limited	32.15	%
	Variance of Return	2107.3275	%%
	Standard Deviation of Return =SQRT(2107.3275)=	45.91	%
	COVARIANCE BETWEEN RETURNS OF LIDAR AND MARKET(S&P/TSX)
	Covariance (A,B)=SUM of (Probability*Deviation of A* Deviation of B)
		p	D1=R1-8.35	D2=R2-32,15	G=p*D1*D2
	State of Economy	Probability	Deviation of Market(%)	Deviation of Lidar (%)	probability*Deviation A*Deviation B
	Boom	0.25	9.65	14.85	35.825625
	Moderate Growth	0.3	2.65	-9.15	-7.27425
	Normal Growth	0.25	-1.35	57.85	-19.524375
	Recession	0.2	-14.35	-77.15	221.4205
				SUM	230.4475
	Covariance of return of Lider and Market(S&P/TSX)	230.4475	%%
	Correlation of Return A and B=(Covariance)/(Std DeviationA* Standard Deviation B)
	Covariance(Lider, market)=230.4475
	Correlation of Return Lider and Market=(230.4475/8.19*45.91)=	0.613168
	ANSWER:
a	Expected Return of Lidar	32.15%
b	S&P/TSX Composite Index
	Expected Return	8.35%
	Variance	67.0275	%%
	Standard Deviation	45.91%
c	Covariance between return of Lidar and market	230.4475	%%
	Correlation between return of Lidar and market	0.61316799
d	Beta Coefficient of Lidar
	Beta=Covariance/Variance of market=230.4475/67.0275	3.43810376