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Homework_set_solutions.pdf
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Homework
Exercises
NB:
These
exercises
are
similar
to
those
that
you
will
encounter
on
the
exam
and
more
difficult
than
those
in
Berk
and
DeMarzo
book.
Making
these
exercises
is
not
obligatory
but
of
course
if
you
do
not
make
them,
most
likely
you
will
not
be
able
to
pass
the
exam.
During
AWVs
these
exercises
will
be
discussed.
Needless
to
say,
additionally
you
should
be
able
to
solve
all
the
problems
at
the
ends
of
Chapters
10-13;
these
problems
are
similar
to
your
MyFinanceLab
tests.
1. It
is
well-known
that
the
volatility
of
gold
prices
has
been
very
low
historically:
around
12%
per
annum.
Lately,
the
annualized
gold
volatility
has
reached
32%.
For
both
historical
and
current
gold
volatilities,
compute
also
the
daily,
weekly
and
monthly
gold
volatilities.
Historic:
day
=
12%/(251)
=
0.757%
Current:
day
=
32%/(251)
=
2.020%
week
=
12%/(52)
=
1.664%
week
=
32%/(52)
=
4.438%
month
=
12%/(12)=
3.464%
month
=
32%/(12)=
9.238%
2. Historical
annualized
return
on
stocks
is
approximately
8%
and
the
annualized
volatility
is
35%.
a)
Compute
daily,
weekly
and
monthly
volatilities.
b) Compute
95%
confidence
intervals
for
daily,
weekly,
monthly
and
yearly
expected
returns.
a) day
=
35%/(251)
=
2.209%
,
week
=
35%/(52)
=
4.854%
,
month
=
35%/(12)=
10.104%
b) Return
per
month:
1.08^(1/12)-1=
0.643%
Return
per
week:
1.08^(1/52)-1=
0.148%
Return
per
day:
1.08^(1/251)-1=
0.0307%
[R
-
1.96*,
R
+
1.96*]
yearly:
[8%-1.96*35%,
8%+1.96*35%]=
[-60.6%,
+76.6%]
etc.
3. The
following
table
gives
monthly
closing
prices
of
two
stocks
for
the
last
12
months.
Date
QLogic
Mattel
Dec
27.6
22.8
Jan
25.4
21.7
Feb
26.4
22.6
Mar
28.6
23.5
Apr
27.9
23.6
May
25.2
22.0
Jun
25.8
22.8
Jul
26.1
23.2
Aug
21.5
19.9
Sep
19.2
17.2
Oct
19.1
16.3
Nov
19.9
16.4
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a) Compute
monthly
stock
price
returns.
Assume
no
dividends.
Compute
average
monthly
returns.
b) Compute
variances,
volatilities
and
annualized
volatilities
of
both
stock
returns.
c) Compute
the
95%
confidence
intervals
for
the
average
monthly
returns
computed
in
a)
and
for
an
expected
monthly
return.
d) Compute
the
covariance
between
these
stock
returns
and
the
correlation
coefficient.
e) What
are
the
average
return,
variance
and
annualized
volatility
of
the
portfolio
consisting
for
50%
of
QLogic
and
50%
of
Mattel?
f) Now
suppose
you
have
10
000
$
to
invest.
You
borrow
and
short
sell
5
000
$
worth
of
Mattel
stock
and
invest
the
resulting
15
000
$
into
QLogic.
What
is
now
the
expected
return
and
the
monthly
and
yearly
volatility
of
your
portfolio?
g) Explain
what
happens
to
the
portfolio
volatility
in
e)
and
in
f)
if
the
correlation
between
the
stock
increases?
Why
this
happens?
a) Returns(t+1):
(Rt+1-Rt)/Rt
Qlogic:
Return(jan):
(25.4-27.6)/27.6=
-0.0797
or
-7.97%
Return(feb):
(26.4-25.4)/25.4=
0.0394
or
3.94%
etc.
Mattel:
Return(jan):
(21.7-22.8)/22.8=
-4.82%
Return(feb):
(22.6-21.7)/21.7=
4.15%
etc.
R =
1
T
(R1
Var (R) =
1
T ! 1
" (R
+ R2 + ! + RT ) =
1 T
! Rt
T t = 1 :
! R)
Var(RQlogic,
monthly)=(
(-7.97%
-
-2.631%)2
+
(3.94%
+
2.631%)2
+
)/(11-1)=
0.00622,
Qlogic(monthly)=
(0.00622)=
7.89%,
Qlogic(yearly)=
(12)*7.89%=
27.32%
Var(RMattel,monthly)=(
(
-4.82%-
-2.734%)2
+
(4.15%
+
2.734%)2
+
)/(11-1)
=
0.00451,
Mattel(monthly)=
(0.00451)=
6.71%,
Mattel(yearly)=
(12)*6.71%=
23.26%
c) Average:
[-2.631%
-1.96*(7.89%/(11)),
-2.631%
+1.96*(7.89%/(11))]=
[-7.29%,
2.03%]
you
divide
by
sqrt(11)
because
you
have
less
uncertainty
Expected:
[-2.631%
-1.96*7.89%,
-2.631%
+1.96*7.89%]=
[-18.09%,
12.83%]
Here
you
do
not
divide
by
sqrt(11)
because
you
have
more
uncertainty,
its
about
expectations
For
Mattel:
Average=[-6.70%,
1.23%],
Expected=
[
-15.89%,
10.43%]
d)
Cov(Ri ,R j ) =
t =1
1
" (Ri,t ! Ri ) (R j ,t ! R j )
T ! 1 t
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Corr (Ri ,R j ) =
Cov(Ri ,R j )
SD(Ri ) SD(R j )
Correlation=i,j=0.004823/(7.89%*6.71%)=
0.9165
normalized
covariance,
always
between
-1
and
+1.
If
Ri
on
average
changes
with
x%
then
Rj
will
on
average
change
with
i,j*x%
e)
RP = x1 R1 + x2 R2 + ! + xn Rn =
! xR
i
Rp=0.5*-2.631%+0.5*-2.734%=-
2.682%
P
1
1
2
2
1 2
1
2
Var(Rp)=
0.5^2*0.00622
+0.5^2*0.00451
+
2*0.5*0.5*0.004823
=
0.00511
(monthly)=
(0.00511)=
7.147%,
(yearly)=
(12)*
7.147%=
24.76%
0,9
0,8
0,7
0,5
0,6
0,4
0,3
0,2
0,1
-0,1
-0,2
-0,3
-0,4
-0,5
-0,6
-0,7
-0,8
-1
16,00%
14,00%
12,00%
10,00%
8,00%
6,00%
4,00%
2,00%
0,00%
-0,9
volatility (%)
correlation
Volatility(portfolio
3e)
Volatility(portfolio 3f)
4. Do
exactly
the
same
as
in
the
previous
exercise
(questions
a)-e)),
but
now
for
the
Dow
Jones
and
NIKKEI
example
(the
data
is
at
the
end
of
the
exercise
set:
Appendix
1).
Note
that
there
daily
closing
prices
(and
not
monthly)
are
given.
You
can
use
Excel
or
scientific
calculator.
Instead
of
question
f),
consider
the
following:
you
have
1
M
$
to
invest
and
you
borrow
additional
0,5
M
$
against
US
risk
free
rate
of
3%.
You
invest
your
resulting
1,5
M
$
equally
in
Dow
Jones
and
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Nikkei.
What
is
the
expected
return
and
the
volatility
of
your
portfolio?
(disregard
the
exchange
rate
volatility).
a) Returns(t+1):
(Rt+1-Rt)/Rt
Nikkei:
Dag
1:
(16788-16506)/16506=
1.7085%
Dag
2:
(16700-16788)/16788=
-0.5242%
etc.
DJ:
Dag
1:
(12163-12002)/12002=
1.3414%
Dag
2:
(12090-12163)/12163=
-0.6002%
etc
Nikkei:
Rn(day)=
0.1046%,
Dow
Jones:
Rdj(day)=
0.1323%
Rn(monthly)=
(1+0.1046%)^(251/12)-1
=
2.21%
Rdj(monthly)=2.80%
b)
Var(N,daily)=
(
(0.17085%-0.1046%)2
+
(-0.5242%-0.1046%)2
+
..)
/
(20-1)
=
0.0001612
N(daily)=
(0.0001612)=
1.2698%
,
N
(Yearly)=(251)*1.2698%
=
20.12%
Var(DJ,
daily)=
(
(1.3414%-0.1323%)2
+
(-0.6002%-0.1323%)2
+
)
/(20-1)=
0.0000484
DJ
(daily)=
(0.0000484)=
0.6954%
,
DJ
(Yearly)=(251)*0.6954%
=
11.02%
c)
Nikkei:
average:[-9.2%,
13.6%]
and
expected:
[-37.2%,
41.6%]
Dow
jones:
Average:[-3.4%,
9.0%]
,
expected:[-18.8%,
24.4%]
d) Cov(N,
DJ)=
((1.7085%-0.1046)*(-0.5242%-0.1323%)
+
(-0.5242%-0.1046%)*(-0.6002%-
0.1323%)
+
)/(20-1)
=
0.00000215
Corr(N,
DJ)=
0.00000215/(1.2698%*0.6954%)
=
-0.0244
e) Rp=
0.5*0.1046%
+
0.5*0.1323%
=
0.118%,
Rp(Yearly)=
(1+0.118%)^251
-1
=
34.61%
Var(Rp)=
0.5^2*1.2698%^2
+
0.5^2*0.6954%^2
+
2*0.5*0.5*0.00000215=
0.000051
VolRp,
Yearly)=
(0.000051*251)
=
11.35%
f) Weights:
Nikkei=
0.75M/1M=0.75,
DJ=0.75M/1M=0.75,
Rf=-0.5M/1M=-0.5
Rf(daily)=
1.03^(1/251)-1=
0.0118%
Rp=
0.75*0.1046%
+
0.75*0.1323%
-0.5*0.0118%
=
0.172%,
Rp(Yearly)=
(1+0.172%)^251
-1
=
52.87%
Var(Rp)=
0.75^2*1.2698%^2
+
0.75^2*0.6954%^2
+
2*0.75*0.75*0.00000215=
0.000115
VolRp,
Yearly)=
(0.000051*251)
=
17.02%
g) For
both
portfolios:
correlation
increases
volatility
increase
5. A
portfolio
consists
of
three
stocks,
30%
is
invested
in
the
first
stock,
25%
in
the
second
stock
and
45%
in
the
third.
The
yearly
average
return
is
10%
for
the
first
stock,
12%
for
the
second
and
13%
for
the
third.
The
below
table
gives
the
historical
Variance-Covariance
matrix
of
the
(yearly)
stock
returns:
0.1
0.04
0.03
0.04
0.2
0.04
0.03
0.04
0.6
a)
Compute
the
average
return
of
the
portfolio.
b) Compute
the
yearly
variance
and
volatility
of
the
portfolio
return.
c) Suppose
you
have
1M
$
to
invest
and,
using
this
as
the
collateral,
you
borrow
the
additional
1M
$
against
the
risk
free
rate
of
5%.
You
then
invest
your
available
2M
in
the
same
three
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stocks
and
in
the
same
proportion
as
above.
What
is
now
your
expected
return
and
the
annualized
volatility?
d) Same
as
c),
only
now
you
invest
half
of
your
1M
into
risk
free
bond
paying
3%
p/a
and
the
remaining
half
into
the
above
three
stocks
in
the
same
proportions.
What
is
now
your
expected
return
and
the
annualized
volatility?
a) Rp=
x1*R1+x2*R2+x3*R3
=
0.3*10%+0.25*12%+0.45*13%=
11.85%
b)
So
Var(Rp)=
(w1)2*var(R1)
+
(w2)2*var(R2)
+
(w2)2*var(R2)
+
2*(w1*w2*Cov(R1,R2))
+
2*(w1*w3*Cov(R1,R3))
+
2*(w2*w3*Cov(R2,R3))
Var(Rp)=
(0.3)2*0.1
+
(0.25)2*0.2
+
(0.45)2*0.6
+
2*(0.3*0.25*0.04)
+
2*(0.3*0.45*0.03)
+
2*(0.25*0.45*0.04)
=
0.1661
Vol(Rp)
=
(Var(Rp)
=
(0.1661)
=
40.755%
c) Invest:
2M
in
stocks
1M
at
5%
Rp
=
2*Rs
1*Rf
=
2*11.85%
-
5%
=
18.70%
Vol(Rp)=
2*40.755%
=
81.51%
d) Invest:
0.5M
in
stocks
+
0.5M
in
Rf
bond
at
3%
Rp=
0.5*Rs
+
0.5*3%
=
0.5*11.85%
+
0.5*3%
=
7.425%
Vol
(Rp)=
0.5*40.755%
=
20.38%
6. A
portfolio
consists
of
8
stocks.
The
following
is
known
about
the
weights
wi,
the
volatilities
and
the
correlations:
w1
=
w2
=
0.2;
w3
=
w4
=
w5
=
w6
=
w7
=
w8
=
0.1
corr(ij)
=
constant
=
0.3
vol(i)
=
constant
=
40%
a) Compute
the
variance
and
volatility
of
the
portfolio
return.
b) Now
suppose
all
the
weights
are
the
same.
Again
compute
the
variance
and
volatility
of
the
portfolio
return.
c) As
the
number
of
these
stocks
in
your
portfolio
increases,
what
happens
to
the
expected
return
and
the
volatility
of
your
portfolio?
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8. A
portfolio
consists
of
four
stocks:
KLM,
BP,
Nestle
en
Alcom.
25%
is
invested
in
each
stock.
The
yearly
average
returns
are
13.8
%
for
KLM,
9
%
for
BP,
14.2
%
for
Nestle
en
20
%
for
Alcom.
The
yearly
volatilities
are
0.55,
0.24,
0.15
and
0.3
respectively
for
KLM,
BP,
Nestle
en
Alcom.
The
next
table
gives
the
historical
correlation
matrix:
KLM
BP
Nestle
Alcom
KLM
1
0.3
0.3
0.5
BP
0.3
1
0.3
0.4
Nestle
0.3
0.3
1
0.3
Alcom
0.5
0.4
0.3
1
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11. An
amount
of
100
000
Euros
is
invested
in
oil
futures.
In
the
Appendix
3
you
will
find
400
sorted
historical
changes
in
the
portfolio
value
after
one
day.
a) Compute
historical
VaR(95%,
1
day),
VaR(97.5%,
1
day),
VaR(99%,
1
day)
and
the
corresponding
Expected
Shortfalls.
b) Furthermore,
it
is
known
that
the
average
portfolio
value
change
in
1
day
is
equal
to
45
and
the
standard
deviation
of
the
value
changes
is
2100.
Compute
the
same
three
VaRs
as
in
a)
with
the
help
of
the
normal
distribution
assumption.
Give
your
opinion
about
the
suitability
of
the
normal
distribution
for
this
portfolio.
c) Compute
the
VaR(95%,
5
days)
en
VaR(95%,
10
days)
with
the
help
of
your
answers
in
b).
Solution
in
excel
12. Portfolio
consists
of
stocks
all
with
the
same
volatility
(40%)
and
the
same
correlation
of
0.3
between
each
pair
of
stocks.
a) Imagine
this
is
the
model
for
the
AEX
index
(the
index
is
of
course
a
value-weighted
portfolio;
however,
here
just
for
the
purpose
of
illustration
we
assume
it
is
an
equally
weighted
portfolio).
What
is
the
volatility
of
the
index
(i.e.,
of
a
portfolio
consisting
of
25
of
these
stocks)?
b) How
many
stocks
of
this
kind
your
portfolio
should
have
so
that
the
portfolio
volatility
is
30%
?
And
how
many
stocks
so
that
the
portfolio
volatility
is
20%?
c) What
is
the
lowest
portfolio
volatility
that
you
can
achieve
using
these
stocks?
a) Var=
0.42=
0.16,
Cov=0.4*0.4*0.3=
0.048
Var(Rp)
=
1/n
(average
variance
of
the
individual
stocks)
+
(1-1/n)(average
covariance
between
the
stocks)
=
(1/25)*0.16
+
(1-1/25)*(0.048)=
0.05248
Vol(Rp)=
(0.05248)=
22.91%
b) Via
excel
solver:
Vol(Rp)=
30%
stock=2.66,
so
2
Vol(Rp)=20%
kan
niet
c) Using
infinite
number
of
stocks:
first
term=0
and
second
term=
0.048
So
Vol=(0.048)=
21.91%
13. Calculate
95%
1-day
VaR
for
the
following
portfolio:
20-mln
$
portfolio
with
the
annual
return
volatility
of
22%.
Assume
that
the
average
daily
return
is
zero.
20M
$,
average
daily
return
=
0%,
annual
return
volatility
=
22%
VaR(95%,
1
day)
=
ABS(20M
*
(0
1.645
*
0.22/sqrt(251)))=
0.457M
14. Consider
the
Dutch
stock
market.
The
average
market
return
is
10%
p/a
and
risk-free
rate
is
3,25%
p/a.
a) What
is
the
beta
and
the
risk
premium
of
the
Dutch
Treasury
Certificates?
b) What
is
the
beta
and
the
risk
premium
of
the
AEX
index?
c) You
invest
1
mln
euros
in
DTCs
and
2
mln
euros
in
AEX.
What
is
the
beta
of
your
portfolio?
d) TomTom
has
beta
of
2,2
and
Shell
of
0,6.
What
average
return
investors
expect
from
these
companies?
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e) You
can
invest
in
a
company
with
beta
of
1,7
and
the
average
historical
return
of
15%.
On
the
basis
of
CAPM,
would
you
do
that?
a)
DTC
=
0,
risk
premiumDTC
=
0
b)
AEX
=
1,
risk
premiumAEX
=
10
3.25
=
6.75%
c)
portfolio
=
wAEX
*
AEX
+
wDTC
*
DTC
=
2/3
d)
rTomTom
=
rf
+
TomTom
*
(rm
rf)
=
3.25
+
2.2
*
6.75
=
18.1%
rshell
=
rf
+
shell
*
(rm
rf)
=
3.25
+
0.6
*
6.75
=
7.3%
e)
r?
=
rf
+
?
*
(rm
rf)
=
3.25
+
1.7
*
6.75
=
14.725%
<
15%
Yes,
here
is
an
opportunity.
15. You
performed
a
simple
linear
regression
(e.g.,
with
Excel)
to
determine
the
beta
of
a
company.
Your
output
looks
like
this:
Coefficient
Standard
error
Intercept
0,08
0,05
Slope
0,58
0,13
On
the
basis
of
this
output,
give
the
95%
confidence
interval
for
the
beta.
You
also
looked
up
the
beta
for
this
company
on
Bloombergs
website
and
saw
that
it
is
0,7.
Is
this
in
conflict
with
your
results?
95%
Confidence
Interval
for
the
gives
0.58
1.96
*
0.13
=
[0.325
;
0.835]
The
beta
of
0.7
lies
within
the
interval
so
is
not
in
conflict
with
the
findings
16. A
computer
company
has
a
beta
of
1,8.
The
average
market
return
is
9%
and
the
risk
free
rate
is
3,75%.
a) Draw
the
Security
Market
Line.
b) What
average
return
investors
expect
from
this
company?
c) This
company
decided
to
develop
a
new
business
in
computer
games.
The
management
considers
this
business
comparable
to
the
core
business.
What
discount
factor
should
the
management
use
to
discount
future
cash
flows
of
the
new
business?
d) Consultants
claim
that
the
new
business
is
more
risky,
and
is
more
comparable
with
the
core
business
of
Nintendo,
whos
beta
is
2,2.
What
discount
factor
would
consultants
use?
a)
b)
rcomp
=
rf
+
comp
*
(rf
rm)
=
3.75
+
1.8
*
(9-
3.75)
=
13.2%
c)
The
same
risk
as
the
core
business,
so
the
discountfactor
is
the
same
as
the
one
of
the
core
business.
The
discountfactor
is
equal
to
the
expected
return=
13.2%
d)
dfcomp
=
rcomp
=
rf
+
nintendo
*
(rf
rm)
=
3.75
+
2.2
*
(9-
3.75)
=
15.3%
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17. In
the
next
table
you
see
the
average
returns
and
volatilities
of
various
portfolios.
Draw
them
on
a
plot
with
the
volatilities
on
x-axis
and
returns
on
y-axis.
Which
portfolios
are
definitely
not
efficient?
Portfolio
A
B
C
D
E
F
G
H
I
r(%)
15
10
12
20
17
17
15
11.5
13
vol(%)
7.5
6
5
15
12
15
10
4.5
5.5
Portfolio
B,
F
and
G
are
definitely
not
efficient.
There
are
other
portfolios
that
have
a
higher
return
with
the
same
volatility
or
a
lower
volatility
with
the
same
return.
B
vs
C/H/I,
F
vs.
D/E,
G
vs.
A
18. The
betas
of
the
following
companies
are:
2,2
for
Amazon,
1,7
for
Microsoft,
0,4
for
Exxon
and
0,3
for
Coca
Cola,
the
corresponding
volatilities
are
55%,
50%,
40%
and
35%.
The
average
market
return
(represented
by
S&P500)
is
10%,
the
risk
free
rate
is
3,15%
and
the
volatility
of
the
stock
index
is
20%
p/a.
a) Draw
the
Security
Market
Line.
Which
return
investors
expect
from
these
companies?
b) What
are
the
correlations
of
these
four
stocks
with
S&P500?
c) Assume
that
the
correlation
between
Amazon
and
Microsoft
returns
is
0,4
and
all
other
pairwise
correlations
are
0,2.
What
is
the
expected
return
and
the
volatility
of
the
portfolio
equally
invested
in
these
four
stocks?
What
is
the
Sharpe
ratio
of
this
portfolio?
d) Can
you
achieve
the
same
return
but
with
a
lower
volatility
by
investing
in
S&P500
and
US
Treasury
bills?
If
yes,
then
how?
a)
b)
c)
ramazon
=
rf
+
amazon
*
(rm
rf)
=
3.15
+
2.2
*
(10
3.15)
=
18.22%
rmicrosoft
=
rf
+
microsoft
*
(rm
rf)
=
3.15
+
1.7
*
(10
3.15)
=
14.8%
rexxon
=
rf
+
exxon
*
(rm
rf)
=
3.15
+
0.4
*
(10
3.15)
=
5.9%
rcoca-cola
=
rf
+
coca-cola
*
(rm
rf)
=
3.15
+
0.3
*
(10
3.15)
=
5.21%
Formula
11.23
gives:
i
=
(SD(Ri)
*
Corr(Ri,
Rmkt))/SD(Rmkt).
Corr(
Ramazon,
Rmkt)
=
(2.2*20)/55
=
0.8
Corr(
Rmicrosoft,
Rmkt)
=
(1.7*20)/50
=
0.68
Corr(
Rexxon,
Rmkt)
=
(0.4*20)/40
=
0.2
Corr(
Rcoca-cola,
Rmkt)
=
(0.3*20)/35
=
0.171429
rportfolio
=
0.25*
ramazon
+
0.25*
rmicrosoft
+
0.25*
rexxon
+
0.25*
rcoca-cola
=
11.0325%
Cov(Ri,Rj)=
SD(Ri)*SD(Rj)*Corr(Ri,Rj),
on
the
diagonal
variances
of
the
stocks
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Var-Covar
matrix
0,3025
0,11
0,11
0,25
0,044
0,04
0,0385
0,035
0,044
0,04
0,16
0,028
0,0385
0,035
0,028
0,1225
varianceportfolio
=
0.252*0.3025+
0.252*0.25+
0.252*0.16+
0.252*0.1225+
2*0.252*0.11
+
2*0.252*0.04
+2*0.252*0.0385
+2*0.252*0.04
+2*0.252*0.035
+0.028
=0.089,
volatilityportfolio
=
sqrt(0.089)
=
29.85%
SharpeRatioportfolio
=
premiumportfolio
/
volatilityportfolio
=
7.8825%/29.85%
=
0.264
d)
Returnportfolio
=
11.0325%.
You
have
to
earn
a
premium
of
(11.0325-3.15)
=
7.8825%
with
the
investment.
The
S&P
earns
a
premium
of
(10-3.15)
=
6.85%.
So
put
7.88525/6.85
=
1.15
of
your
wealth
in
S&P
to
get
the
same
return.
Volatility
is
(1.152*20%2)
=
23%
,
so
YES.
19. Let
the
average
return
on
S&P500
be
8%
p/a
and
the
risk-free
rate
3%
p/a.
a) What
are
the
betas
and
risk
premia
on
S&P500
and
on
US
Treasury
bills?
b) You
invest
3M
in
US
Treasuries
and
7M
in
S&P500.
What
is
the
beta
of
your
investment?
c)
McDonalds
corporation
has
the
beta
of
0.4
and
Apple
has
the
beta
of
1,7.
What
return
do
investors
expect
from
these
companies?
d) Suppose
the
volatilities
of
McDonalds
and
Apple
are
35%
and
50%
p/a
respectively.
How
correlated
are
the
returns
of
McDonalds
and
of
Apple
with
the
American
stock
market,
if
the
volatility
of
S&P500
is
20%
p/a?
e) What
is
the
average
return
and
the
volatility
of
the
portfolio
consisting
of
50%
of
McDonalds
and
50%
of
Apple,
if
the
correlation
between
returns
on
these
two
stocks
is
20%?
What
is
the
Sharpe
ratio
of
this
portfolio?
f) How
can
you
achieve
the
same
return
but
with
a
lower
volatility
by
investing
in
S&P500
and
US
Treasury
bills?
a)
TB
=
0,
risk
premiumTB
=
0,
S&P
=
1,
risk
premiumS&P
=
8%
3%
=
5%
b)
portfolio
=
wS&P
*
S&P
+
wTB
*
TB
=
0.7
c)
rmacd
=
rf
+
macd
*
(rf
rm)
=
3
+
0.4
*
(8
3)
=
5
rapple
=
rf
+
apple
*
(rf
rm)
=
3
+
1.7
*
(8
3)
=
11.5
d)
Formula
11.23
gives:
i
=
(SD(Ri)
*
Corr(Ri,
Rmkt))/SD(Rmkt)
Corr(Ri,
Rmkt)=SD(Rmkt)*i/SD(Ri)
Corr(
Rmacd,
Rmkt)
=
(0.4*20)/35
=
0.228571
Corr(
Rapple,
Rmkt)
=
(1.7*20)/50
=
0.68
e)
Returnportfolio
=
0.5
*
returnmacd
+
0.5
*
returnmacd
=0.5*5+0.5*11.5=
8.25%
varportfolio=
0.52*35%2
+
0.52*50%2
+
0.5*0.5*0.20*35%*50%
=
0.22125
dus
volatilityportfolio
=
47.037%
SharpeRatioportfolio
=
premiumportfolio
/
volatilityportfolio
=
5.25%/47.037%
=
0.112
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f)
The
premiumportfolio
=
8.25%
-
3%
=
5.25%.
The
premiumS&P
=
5%.
You
have
to
invest
5.25/5
=
1.05
of
your
wealth
in
S&P
to
get
the
same
return.
This
gives
a
volatility
of
sqrt(1.052*20%2)
=
21%
20. Shell
is
considering
a
new
oil
exploration
project
in
Australia.
The
beta
of
Shell
(with
respect
to
the
market
(S&P500))
is
0.6,
the
risk-free
rate
3%
and
the
market
risk
premium
7%.
a) What
is
the
cost
of
capital
for
this
project,
if
we
assume
it
is
as
risky
as
the
core
business
of
Shell?
b) If
we
use
Carhart
4-factor
model,
what
is
then
the
cost
of
capital?
(Shell
finance
people
have
estimated
its
betas
with
respect
to
SMb
portfolio
(0.2),
HML
portfolio
(0.6)
and
momentum
portfolio
(-0.3)
and
used
historical
returns
on
respective
portfolios
given
in
Table
13.1).
a)
The
cost
of
capital
is
the
expected
return:
CoCshell
=
rshell
=
rf
+
shell
*
(rf
rm)
=
3
+
0.6
*
7
=
7.2%
b)
CoCshell
=
rshell
=
rf
+
S&P
*
7
+
SmB
*
SmB
+
HmL
*
HmL
+
mom
*
mom
Get
the
information
using
table
13.1
of
the
book,
this
gives:
Monthly
returns:
SMB=0.23%,
HML=0.41%,
MOM=0.77%,
in
the
model
yearly
returns
are
used
CoCshell
=
rshell
=
3
+
0.6
*
7
+
0.2
*2.80%
+
0.6
*
5.03%
+
(-0.3)
*
9.64%=
6.09%
Additional
problems
related
to
Chapter
12
Consider
the
following
information
regarding
corporate
bonds
(there
was
a
mistake
in
this
table
in
the
original
exercise
sheet:
the
average
beta
for
BBB
debt
is
0.1
and
NOT
1.0):
Rating
AAA
AA
A
BBB
BB
B
CCC
Average
Default
Rate
0.0%
0.0%
0.2%
0.4%
2.1%
5.2%
9.9%
Recession
Default
Rate
0.0%
1.0%
3.0%
3.0%
8.0%
16.0%
43.0%
Average
Beta
0.05
0.05
0.05
0.1
0.17
0.26
0.31
21. Wyatt
Oil
has
a
bond
issue
outstanding
with
seven
years
to
maturity,
a
yield
to
maturity
of
7.0%,
and
a
BBB
rating.
The
bondholders
expected
loss
rate
in
the
event
of
default
is
70%.
Assuming
a
normal
economy,
what
is
the
expected
return
on
Wyatt
Oil's
debt?
rd
=
ytm
-
prob(default)
loss
rate
=
7%
-
0.4%*(70%)
=
6.72%
22. Rearden
Metal
has
a
bond
issue
outstanding
with
ten
years
to
maturity,
a
yield
to
maturity
of
8.6%,
and
a
B
rating.
The
bondholders
expected
loss
rate
in
the
event
of
default
is
50%.
Assuming
the
economy
is
in
recession,
what
is
the
expected
return
on
Rearden
Metal's
debt?
rd
=
ytm
-
prob(default)
loss
rate
=
8.6%
-
16.0%*(50%)
=
0.6%
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!
!
!, !""
!, !!! !, !""
!! = !! + !! =
!. ! +
!. ! = !. !!"#
!
!
!, !!!
!, !!!
Since
Rearden
has
a
rating
of
AAA,
the
appropriate
debt
beta
from
the
table
is
0.05.
!
!
!, !""
!, !"" !, !""
!! = !! + !! =
!. ! +
!. !" = !. !"#!$$
!
!
!, !""
!, !""
For
other
companies,
the
same
arguments
can
be
used.
24. Suppose
that
because
of
the
large
need
for
steel
in
building
railroad
infrastructure,
Taggart
Transcontinental
and
Rearden
Metal
decide
to
into
one
large
conglomerate.
Estimate
the
asset
beta
for
this
new
conglomerate.
conglomerate
8,000
7, 200
( 0.6625) +
( 0.709722 ) = 0.684868
8,000 + 7, 200
8,000 + 7, 200
25. Galt
Industries
has
a
market
capitalization
of
$50
billion,
$30
billion
in
BBB
rated
debt,
and
$8
billion
in
cash.
If
Galt's
equity
beta
is
1.15,
what
is
then
the
Galt's
underlying
asset
beta?
!! =
!
!!
!"
!" !
!! +
!! =
!. !" +
!. ! = !. !"
!+!
!+!!
!" + !" !
!" + !" !
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26. Your
firm
is
planning
to
invest
in
a
new
electrostatic
power
generation
system.
Electrostat
Inc
is
a
firm
that
specializes
in
this
business.
Electrostat
has
a
stock
price
of
$25
per
share
with
16
million
shares
outstanding.
Electrostat's
equity
beta
is
1.18.
It
also
has
$220
million
in
debt
outstanding
with
a
debt
beta
of
0.08.
If
the
risk-free
rate
is
3%,
and
the
market
risk
premium
is
6%,
estimate
of
your
cost
of
capital
for
electrostatic
power
generators.
U =
E
D
$25 16
220
E +
D =
1.18 +
0.08 = 0.789677
E+D
E+D
$25 16 + 220
$25 16 + 220
ri
=
rrf
+
(rm
-
rrf)
=
.03
+
.789677(.06)
=
.07738
or
7.74%
27. Luther
Industries
has
25
million
shares
outstanding
trading
at
$18
per
share.
In
addition,
Luther
has
$150
million
in
outstanding
debt.
Suppose
Luther's
equity
cost
of
capital
is
13%,
its
debt
cost
of
capital
is
7%,
and
the
corporate
tax
rate
is
40%.
Calculate:
a) Luther's
unlevered
cost
of
capital.
b) Luther's
after-tax
debt
cost
of
capital.
c) Luther's
weighted
average
cost
of
capital.
a)
!
!
$!" !"
$!"#
!! =
!! +
!! =
!"% +
!% = !!. !%
!+!
!+!
$!" !" + $!"#
$!" !" + $!"#
b) Effective
after-tax
interest
rate
=
r(1
-
Tc)
=
.07(1
-
.40)
=
.042
or
4.2%
c) !! =
!
!!!
!! +
!
!!!
!! ! !! =
$!" !"
$!"#
!"% +
!% ! !. ! = !". !%
$!" !" + $!"#
$!" !" + $!"#
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Verspreiden niet toegestaan | Gedownload door: Marijn Doeleman | E-mail adres: marijndoeleman@gmail.com
Appendix
2
9,2837
9,4185
9,5057
9,6009
9,7032
9,7648
9,7718
9,7779
9,78
9,7802
9,7909
9,7945
9,7956
9,8004
9,817
9,822
9,8245
9,8249
9,8441
9,8596
9,8615
9,8712
9,8724
9,876
9,8841
9,8903
9,8955
9,897
9,9044
9,9074
9,9099
9,9143
9,9183
9,9256
9,9271
9,9282
9,9408
9,9446
9,9469
9,9477
9,9482
9,9504
9,9537
9,9559
9,9562
9,9581
9,9651
9,9728
9,9769
9,984
9,9879
9,9887
9,9898
9,992
9,9959
10,0044
10,007
10,0103
10,0131
10,0132
10,0145
10,0163
10,0221
10,0233
10,0358
10,0379
10,0392
10,0516
10,0521
10,0579
10,079
10,0856
10,0874
10,0877
10,0882
10,0916
10,0946
10,0967
10,099
10,1053
10,1073
10,1186
10,119
10,1211
10,1256
10,1364
10,141
10,1441
10,1473
10,1575
10,1583
10,1921
10,199
10,2429
10,2492
10,2494
10,2563
10,2746
10,2767
10,3534
Verspreiden niet toegestaan | Gedownload door: Marijn Doeleman | E-mail adres: marijndoeleman@gmail.com
Appendix
3
-8260
-5930
-5481
-5008
-4891
-4809
-4808
-4683
-4587
-4432
-4387
-4233
-4145
-4128
-4117
-3793
-3751
-3669
-3543
-3497
-3469
-3425
-3326
-3277
-3202
-3101
-3093
-2957
-2928
-2920
-2895
-2881
-2831
-2807
-2801
-2792
-2697
-2621
-2550
-2543
-2538
-2484
-2458
-2429
-2418
-2407
-2376
-2358
-2300
-2281
-2247
-2226
-2222
-2209
-2203
-2198
-2123
-2105
-2097
-2075
-2047
-2020
-2009
-1968
-1954
-1934
-1923
-1911
-1902
-1894
-1889
-1874
-1858
-1836
-1834
-1779
-1751
-1741
-1724
-1720
-1718
-1693
-1689
-1682
-1680
-1676
-1606
-1567
-1554
-1547
-1510
-1485
-1472
-1433
-1430
-1416
-1394
-1390
-1361
-1342
-1341
-1331
-1287
-1248
-1220
-1214
-1208
-1197
-1189
-1160
-1149
-1103
-1058
-1047
-1017
-1014
-1009
-987
-982
-977
-964
-951
-939
-922
-911
-897
-888
-874
-868
-801
-775
-770
-764
-725
-719
-696
-664
-645
-631
-610
-586
-568
-564
-563
-509
-483
-482
-371
-350
-347
-347
-340
-339
-337
-334
-326
-324
-323
-322
-316
-314
-304
-236
-224
-224
-220
-220
-219
-208
-169
-125
-119
-114
-113
-109
-109
-108
-107
-107
-102
-102
-102
-101
-99
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
92
102
102
104
105
109
110
113
118
209
217
217
219
222
227
232
239
246
306
318
330
335
339
350
360
361
409
436
524
526
534
538
543
573
596
597
598
624
646
648
664
665
680
703
725
743
756
766
797
802
805
813
817
823
859
882
902
918
924
932
934
964
973
976
1002
1002
1005
1016
1044
1074
1102
1105
1117
1136
1145
1149
1202
1204
1207
1214
1229
1244
1261
1263
1276
1294
1299
1325
1399
1399
1407
1418
1421
1423
1424
1433
1438
1439
1466
1494
1593
1630
1639
1673
1687
1690
1695
1706
1754
1764
1771
1772
1791
1818
1863
1863
1965
1990
1993
2019
2045
2052
2076
2090
2113
2126
2128
2149
2151
2158
2188
2195
2205
2208
2235
2240
2273
2291
2310
2339
2362
2365
2373
2396
2461
2464
2469
2476
2484
2546
2547
2556
2641
2641
2641
2644
2721
2756
2834
2861
2872
2938
3069
3151
3158
3199
3293
3303
3432
3467
3575
3588
3597
3639
3649
3728
3775
3776
3916
3997
4004
4167
4197
4253
4338
4367
4457
4651
4887
4979
5113
6494
Verspreiden niet toegestaan | Gedownload door: Marijn Doeleman | E-mail adres: marijndoeleman@gmail.com