Question

Calculate the expected rate of return on each alternative, and fill in the blanks on the row for r in the previous table. PLEASE SHOW YOUR WORK.

MERRILL FINCH INC. 8-23 RISK AND RETURN Assume that you ente job as a financial planner with Merrill Finch In ment is to invest $100,000 for a client. Because the 1 year you have been instructed to plan for you to the investment alternatives in the following outcomes. For now, disregard the items at the bottom r ted with a major in finance. You just landed a in finance. You just r ocation Tourist ot h ed in a businesatte Furth your boss has restricte with the probabilities and associate the date you will fill in the blanke later) Returns on Alternative Investments کن 105 125 25 25 Estimated Rate of Return State of the High Economy Probability Tills Two-Stock Tech Collections Rubber Portfolio Recession Portfolio 3.0% 029.5 245 3.5 (19.5 Below average Q254 Average (5.5) 110 Above average 275 (5.0) 22.5 Boom 0200 1.29 112 CV Sharpe ratio -0.16 054 -0.50 Note: "The estimated returns of US. Rubber do not always move in the same direction as the overall economy. For example, when the economy is below average, consumers purchase fewer tires than they would if the economy was stronger However, if the economy is in a flat-out recession, a large number of consumers who were planning to purchase a new car may choose to wait and instead purchase new tires for the car they currently own Under these circumstances, we would expect U.S. Rubber's stock price to be higher if there is a recession than the economy is just below average Merrill Finch's economic forecasting staff has developed probability estimates for the state of the economy, and its security analysts developed a sophisticated computer program to estimate the rate of return on each alternative under each state of the economy. High Tech Inc. is an electronics firm Collections Inc. collects past-due debts, and U.S. Rubber manufactures tires and various other rubber and plastics products. Merrill Finch also maintains a market portfolio" that owns a market-weighted fraction of all publicly traded stocks: you can invest in that portfolio and thus obtain average stock market results. Given the situation described, answer the following questions a. 1. Why is the T-bill's return independent of the state of the economy? Do T-bills promise a com- pletely risk-free return? Explain. 2. Why are High Tech's returns expected to move with the economy, whereas Collections's are expected to move counter to the economy? b. Calculate the expected rate of return on each alternative, and fill in the blanks on the row for in the previous table. You should recognize that basing a decision solely on expected returns is appropriate only for risk-neutral individuals. Because your client, like most people, is risk-averse, the riskiness of each alternative is an important aspect of the decision. Une possible measure of risk is the standard deviation of returns. in the table 1. Calculate this value for each alternative and fill in the blank on the row for 2. What type of risk is measured by the standard deviation? orecasting staff has dephisticated computer program an electronics fir

Answer 1

here only calcularin of Expected Ristiwin is asked TOT 3PiR di!_where, Expected Relwin Pi: Poobability 20). Die Retwin m Security 01) T-bills- (0.183+10.2x3) + (04x3+ (0-2X3)+ 12 CO1x3) 0.3 + 0.6 + 1.2 +06+03 2) High Tech (0X-24.5) + (0-24-9.5+0.4x 125 +- (02x27.5) + (0 X 4/2.5 . -2.95 + (-.9 +5 +5.5+4.25 -2.95 1.9 +5 +5.5 +425 - I 9.9.11

(9) Collection Coureddy given) - 1.27- _(4) U.SRubber Calready given): 7,34 -(524_Hayret. Portfolio Coready given): 8.0% (6) TWO - Stocis Mauricet poorfolio: it will be the Wiegheted wegasse Of. two Sous T4401 bien (05*9.9) + (05x1.2) 4.95 + = 5.55 OG or 5.61] . another cei Probability rothd:- return ceil -2.5 05 Cavesar of High tech collec 5.8 0.4 0.2 0.1 11.3 pe 2 PiR? - (0.18-25) + (0-2X057 +0.44587 +(9:2x11:3) + 01x113 - 1 5.610

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