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Dure ahor
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Principios de la solucin directiva de l
as finanzas
Lorenzo J. Descripcin

de los RECURSOS de S

del INSTRUCTOR del riesgo y

de la vuelta del CAPTULO 5 de Gitman
' que
este captulo se centra en los fundamentales del riesgo y de la relacin de la vuelt
a de activos y de su valuacin. Para
el solo activo sostenido en el aislamiento, el riesgo se mide con la distribucin
de la probabilidad y su estadstica asociada:
el medio, la desviacin de estndar, y el coeficiente de variacin. El concepto de la
diversificacin es examinado
midiendo el riesgo de una lista de los activos que se correlacionan perfectament
e positivamente, correlacionado perfectamente negativamente,
y los que sean sin correlacin. Despus, el captulo mira la diversificacin internacio
nal y su efecto sobre riesgo.
El modelo de tasacin de activo fijo (CAPM) entonces se presenta como herramienta
de la valuacin para las seguridades y como explicacin
general del riesgo-vuelve la compensacin implicada en todos los tipos de transacc
iones financieras.
Los asuntos de este
captulo de PMF EL DISCO no se cubre en el profesor particular de PMF o el Problem
-Solver de PMF.
Las plantillas de la hoja de balance
de las plantillas de PMF se proporcionan para los problemas siguientes:
Autoprueba 2
del anlisis de la lista de la autoprueba 1
del asunto del problema beta y coeficiente
del problema 5-7 de CAPM de lnea
del mercado de seguridad del problema 5-26 de la variacin, riesgo
del captulo 5 de SML y vuelta
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Siddiqui 114

Dure aho

los ejemplos siguientes de la gua del estudio se sugieren para la presentacin de l

a sala de clase:

Asunto 4
del ejemplo Actitudes 6
del riesgo Determinacin grfica de 12
beta El impacto del mercado cambia en el riesgo
de vuelta y la vuelta del captulo 5
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RESPUESTAS PARA REPASAR riesgo

Dure aho

de las PREGUNTAS 5-1 se define como la ocasin de la prdida financiera, segn lo medi
do por la variabilidad de las vueltas previstas asociadas
a un activo dado. Un responsable debe evaluar una inversin midiendo la ocasin de
la prdida, o
del riesgo, y de comparar el riesgo previsto a la vuelta prevista. Algunos acti
vos se consideran riesgo-libres;
los ejemplos mas comunes son U. S. Ediciones del Hacienda.
5-2 la vuelta en una inversin (aumento o
lquier excedente de las distribuciones de
al perodo definido. Se expresa como por
rodo. El frmula
es:
[ ]
La vuelta =
(valor del conclusin - valor inicial) +
del valor inicial

prdida total) es el cambio en valor ms cua

efectivo
ciento de la inversin del comenzar-de--pe

vuelta observada

de la distribucin de efectivo requiere el activo ser comprada y vendido durante l

os perodos se mide la vuelta.
La vuelta sin realizar es la vuelta que habra podido ser observada si el activo h
aba sido comprado y vendido
durante el perodo la vuelta fue medida.
5-3 A. El encargado financiero riesgo-contrario requiere un aumento a cambio de
un aumento dado en riesgo.
b. El encargado riesgo-indiferente no requiere ningn cambio a cambio de un aument
o en riesgo.
c. El encargado riesgo-que busca acepta una disminucin a cambio de un aumento dad
o en riesgo.
La mayora de los encargados financieros son riesgo-contrarios.
5-4 el anlisis de la sensibilidad evala riesgo del activo usando ms que uno sistema
posible de vueltas para obtener un sentido
de la variabilidad de resultados. The range is found by subtracting the pessimi
stic outcome from the optimistic
outcome. The larger the range, the more variability of risk associated with the
asset.
5-5 The decision maker can get an estimate of project risk by viewing a plot of
the probability distribution,
which relates probabilities to expected returns and shows the degree of dispersi
on of returns. The more
spread out the distribution, the greater the variability or risk associated with
the return stream.

5-6 The standard deviation of a distribution of asset returns is an absolute mea

sure of dispersion of risk about
the mean or expected value. A higher standard deviation indicates a greater pro
ject risk. With a larger
standard deviation, the distribution is more dispersed and the outcomes have a h
igher variability, resulting
in higher risk.
5-7 The coefficient of variation is another indicator of asset risk, measuring r
elative dispersion. It is calculated
by dividing the standard deviation by the expected value. The coefficient of va
riation may be a better basis
than the standard deviation for comparing risk of assets with differing expected
returns.
5-8 An efficient portfolio is one that maximizes return for a given risk level o
r minimizes risk for a given level
of return. Return of a portfolio is the weighted average of returns on the indi
vidual component assets:
Chapter 5 Risk and Return
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=
=
n
1j
jjp kwk

Last

Where n = number of assets, wj = weight of individual assets, and = expected jk

Returns.
The standard deviation of a portfolio is not the weighted average of component s
tandard deviations; the
risk of the portfolio as measured by the standard deviation will be smaller. It
is calculated by applying the
standard deviation formula to the portfolio assets:
kp i
i
n k k
n
= =
( )
( )
2
1 1
5 9 The correlation between a

et return
i
important when evaluating the effec
t of a new a

et on the
portfolio'
overall ri
k. Return
on different a

et
moving in the
ame direct
ion are po
itively correlated,
while tho
e moving in oppo
ite direction
are negatively correlated. A

et
wit

h high po
itive correlation

increa
e the variability of portfolio return
; a

et
with high negative correla
tion reduce the variability of
portfolio return
. When negatively correlated a

et
are brought together throu
gh diver
ification, the
variability of the expected return from the re
ulting combination can be le

th
an the variability or ri
k of
the individual a

et
. When one a

et ha
high return
, the other'
return
are
low and vice ver
a.
Therefore, the re
ult of diver
ification i
to reduce ri
k by providing a patter
n of
table return
.
Diver
ification of ri
k in the a

et
election proce

allow
the inve
tor to re
duce overall ri
k by combining
negatively correlated a

et

o that the ri
k of the portfolio i
le

than the
ri
k of the individual a

et
in it.
Even if a

et
are not negatively correlated, the lower the po
itive correlation
between them, the lower the
re
ulting ri
k
.
5 10 The inclu
ion of foreign a

et
in a dome
tic company'
portfolio reduce
r
i
k for two rea
on
. When
return
from foreign currency denominated a

et
are tran
lated into dollar
, th
e correlation of return
of
the portfolio'
a

et
i
reduced. Al
o, if the foreign a

et
are in countrie

that are le


en
itive to the
U.S. bu
ine

cycle, the portfolio'
re
pon
e to market movement
i
reduced.
When the dollar appreciate
relative to other currencie
, the dollar value of a
foreign currency
denominated portfolio decline
and re
ult
in lower return
in dollar term
. If
thi
appreciation i
due to
better performance of the U.S. economy, foreign currency denominated portfolio

generally have lower
return
in local currency a
well, further contributing to reduced return
.
Political ri
k
re
ult from po

ible action
by the ho
t government that are har
mful to foreign inve
tor
or
po

ible political in
tability that could endanger foreign a

et
. Thi
form of
ri
k i
particularly high in
developing countrie
. Companie
diver
ifying internationally may have a

et

ei
zed or the return of
profit
blocked.
5 11 The total ri
k of a
ecurity i
the combination of nondiver
ifiable ri
k an
d diver
ifiable ri
k. Diver
ifiable
ri
k refer
to the portion of an a

et'
ri
k attributable to firm
pecific, ran
dom event
(
trike
, litigation,
lo

of key contract
, etc.) that can be eliminated by diver
ification. Nondive
r
ifiable ri
k i
attributable to
market factor
affecting all firm
(war, inflation, political event
, etc.). So
me argue that nondiver
ifiable
ri
k i
the only relevant ri
k becau
e diver
ifiable ri
k can be eliminated by c
reating a portfolio of a

et

which are not perfectly po
itively correlated.
5 12 Beta mea
ure
nondiver
ifiable ri
k. It i
an index of the degree of movem
ent of an a

et'
return in
re
pon
e to a change in the market return. The beta coefficient for an a

et c
an be found by plotting the

Chapter 5 Ri
k and Return

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a

et'
hi
torical return
relative to the return
for the market. By u
ing
ta
ti
tical technique
, the
"characteri
tic line" i
fit to the data point
. The
lope of thi
line i
beta
. Beta coefficient
for actively
traded
tock
are publi
hed in Value Line Inve
tment Survey and in brokerage rep
ort
. The beta of a
portfolio i
calculated by finding the weighted average of the beta
of the indi
vidual component a

et
.
5 13 The equation for the Capital A

et Pricing Model i
: kj = RF+[bj x (km
R
F)],
Where:
kj = the required (or expected) return on a

et j.
RF = the rate of return required on a ri
k free
ecurity (a U.S. Trea
ury bill)
bj = the beta coefficient or index of nondiver
ifiable (relevant) ri
k for a

et
j
km = the required return on the market portfolio of a

et
(the market return)
The
ecurity market line (SML) i
a graphical pre
entation of the relation
hip b
etween the amount of

y
tematic ri
k a

ociated with an a

et and the required return. Sy
tematic ri

k i
mea
ured by beta and i

on the horizontal axi
while the required return i
on the vertical axi
.
5 14 a. If there i
an increa
e in inflationary expectation
, the
ecurity marke
t line will
how a parallel
hift
upward in an amount equal to the expected increa
e in inflation. The required r
eturn for a given level
of ri
k will al
o ri
e.
b. The
lope of the SML (the beta coefficient) will be le


teep if inve
tor
b
ecome le

ri
k aver
e, and
a lower level of return will be required for each level of ri
k.
5 15 The CAPM provide
financial manager
with a link between ri
k and return.
Becau
e it wa
developed to
explain the behavior of
ecuritie
price
in efficient market
and u
e
hi
toric
al data to e
timate required
return
, it may not reflect future variability of return
. While
tudie
have

upported the CAPM when
applied in active
ecuritie
market
, it ha
not been found to be generally appl
icable to real corporate
a

et
. However, the CAPM can be u
ed a
a conceptual framework to evaluate the
relation
hip between
ri
k and return.
Chapter 5 Ri
k and Return
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SOLUTIONS TO PROBLEMS
5 1 LG 1: Rate of Return:
1t
t1tt
t
P
)CPP(k

+=

a.
Inve
tment X: Return %50.12
000,20$
)500,1$000,20$000,21($ =+=
Inve
tment Y: Return %36.12
000,55$
)800,6$000,55$000,55($ =+=
b. Inve
tment X
hould be
elected becau
e it ha
a higher rate of return for th
e
ame level of ri
k.
5 2 LG 1: Return Calculation
:
1t
t1tt
t
P
)CPP(k

+=
Inve
tment Calculation kt (%)
A
B
C
D
E

($1,100 $800 $100) $800 25.00

($118,000 $120,000 + $15,000) $120,000 10.83
($48,000
$45,000 + $7,000) $45,000 22.22
($500 $600 + $80) $600 3.33
($12,400
$12,500 + $1,500) $12,500 11.20

5 3 LG 1: Ri
k Preference

a. The ri
k indifferent manager would accept Inve
tment
X and Y becau
e the
e h
ave higher return
than the
12% required return and the ri
k doe
nt matter.
b. The risk-averse manager would accept Investment X because it provides the hig
hest return and has the
lowest amount of risk. Investment X offers an increase in return for taking on
more risk than what the firm
currently earns.
c. The risk-seeking manager would accept Investments Y and Z because he or she i
s willing to take greater
risk without an increase in return.
d. Traditionally, financial managers are risk-averse and would choose Investment
X, since it provides the
required increase in return for an increase in risk.

5-4 LG 2: Risk Analysis

a. Expansion Range
A 24% - 16% = 8%
B 30% - 10% = 20%

b. Project A is less risky, since the range of outcomes for A is smaller than th
e range for Project B.
Chapter 5 Risk and Return
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c. Since the most likely return for both projects is 20% and the initial investm
ents are equal, the answer
depends on your risk preference.
d. The answer is no longer clear, since it now involves a risk-return trade-off.
Project B has a slightly higher
return but more risk, while A has both lower return and lower risk.
5-5 LG 2: Risk and Probability
a. Camera Range
R 30% - 20% = 10%
S 35% - 15% = 20%
b. Possible Probability Expected Return Weighted
Outcomes Pri ki Value (%)
(ki x Pri)
Camera R Pessimistic 0.25 20 5.00
Most likely 0.50 25 12.50
Optimistic 0.25 30 7.50
1.00 Expected Return 25.00
Camera S Pessimistic 0.20 15 3.00
Most likely 0.55 25 13.75
Optimistic 0.25 35 8.75
1.00 Expected Return 25.50
c. Camera S is considered more risky than Camera R because it has a much broader
range of outcomes. The
risk-return trade-off is present because Camera S is more risky and also provide
s a higher return than
Camera R.

Chapter 5 Risk and Return

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5-6 LG 2: Bar Charts and Risk
a.
Bar Chart-Line J
0
0.1
0.2
0.3
0.4
0.5
0.6
0.75 1.25 8.5 14.7Expected Return (%) 5 16.25

Last

Probability

Bar Chart-Line K

0
0.1
0.2
0.3
0.4
0.5
0.6
1 2. 155 8 13.5Expected Return (%)

Probability

b. Weighted
Market Probability Expected Return Value
Acceptance Pri ki (ki x Pri)
Line J Very Poor 0.05 .0075 .000375
Poor 0.15 .0125 .001875
Average 0.60 .0850 .051000
Good 0.15 .1475 .022125
Excellent 0.05 .1625 .008125
1.00 Expected Return .083500
Chapter 5 Risk and Return
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Line K Very Poor 0.05 .010 .000500
Poor 0.15 .025 .003750
Average 0.60 .080 .048000

Last

Good 0.15 .135 .020250

Excellent 0.05 .150 .007500
1.00 Expected Return .080000
c. Line K appears less risky due to a slightly tighter distribution than line J,
indicating a lower range of
outcomes.
5-7 LG 2: Coefficient of Variation:
k
CV k=
a. A 3500.
%20
%7CVA ==
B 4318.
%22
%5.9CVB ==
C 3158.
%19
%6CVC ==
D 3438.
%16
%5.5CVD ==
b. A

et C ha
the lowe
t coefficient of variation and i
the lea
t ri
ky relati
ve to the other choice
.

5 8 LG 2: Standard Deviation ver
u
Coefficient of Variation a
Mea
ure
of Ri
k

a. Project A i
lea
t ri
ky ba
ed on range with a value of .04.
b. Project A i
lea
t ri
ky ba
ed on
tandard deviation with a value of .029. S
tandard deviation i
not the
appropriate mea
ure of ri
k
ince the project
have different return
.
c. A 2417.
12.
029.CVA ==
B 2560.
125.
032.CVB ==
C 2692.
13.
035.CVC ==
D .2344
128.
030.CVD ==
In thi
ca
e project A i
the be
t alternative
ince it provide
the lea
t amoun
t of ri
k for each percent of
return earned. Coefficient of variation i
probably the be
t mea
ure in thi
in


tance
ince it provide
a

tandardized method of mea
uring the ri
k/return trade off for inve
tment
with
differing return
.
Chapter 5 Ri
k and Return
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5 9 LG 2: A

e

ing Return and Ri
k
a. Project 257
1. Range: 1.00

( .10) = 1.10

2. Expected return: ir
n
1i
i Pkk
=
=
Rate of Return Probability Weighted Value Expected Return
ki Pri ki x Pri ir
n
1i
i Pkk
=
=
.10 .01 .001
.10 .04 .004
.20 .05 .010
.30 .10 .030
.40 .15 .060
.45 .30 .135
.50 .15 .075
.60 .10 .060
.70 .05 .035
.80 .04 .032
1.00 .01 .010
1.00 .450
3. Standard Deviation:
=
=
n
1i
i )kk( 2 x Pri
2 Pri )kk( i 2 x Priki k kki )kk( i
.10 .450 .550 .3025 .01 .003025
.10 .450 .350 .1225 .04 .004900
.20 .450 .250 .0625 .05 .003125
.30 .450 .150 .0225 .10 .002250
.40 .450 .050 .0025 .15 .000375
.45 .450 .000 .0000 .30 .000000
.50 .450 .050 .0025 .15 .000375
.60 .450 .150 .0225 .10 .002250
.70 .450 .250 .0625 .05 .003125
.80 .450 .350 .1225 .04 .004900
1.00 .450 .550 .3025 .01 .003025.
.027350
Project 257 = .027350 = .165378

La
t

4. 3675.
450.
165378.CV ==
Project 432
1. Range: .50

.10 = .40

2. Expected return: ir
n
1i
i Pkk
=
=
Rate of Return Probability Weighted Value Expected Return
Chapter 5 Ri
k and Return
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ki Pri ki x Pri ir
n
1i
i Pkk
=
=
.10 .05 .0050
.15 .10 .0150
.20 .10 .0200
.25 .15 .0375
.30 .20 .0600
.35 .15 .0525
.40 .10 .0400
.45 .10 .0450
.50 .05 .0250
1.00 .300

3. Standard Deviation:
=
=
n
1i
i )kk( 2 x Pri
ki k kki )kk( i 2 P ri )kk( i 2 x Pri
.10
.15
.20
.25
.30
.35
.40
.45
.50

.300 .20 .0400 .05 .002000

.300 .15 .0225 .10 .002250
.300 .10 .0100 .10 .001000
.300 .05 .0025 .15 .000375
.300 .00 .0000 .20 .000000
.300 .05 .0025 .15 .000375
.300 .10 .0100 .10 .001000
.300 .15 .0225 .10 .002250
.300 .20 .0400 .05 .002000
.011250

Project 432 = .011250 = .106066

4. 3536.

La
t

300.
106066.CV ==

b. Bar Chart

Project 257
Probability
Chapter 5 Ri
k and Return
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La
t

c.
Summa
ry Stati
tic

Project 257 Project 432
0
0.05
0.1
0.15
0.2
0.25
0.3
10% 30% 40% 60% 70% 80% 100%
Rate of Return
Project 432
10% 20% 45% 50%
Range 1.100 .400
Expected
Return ( k ) 0.450 .300
Standard
Deviation ( ) 0.165 .106 k
Coefficient of
Variation (CV) 0.3675 .3536
0
0.05
0.15
0.2
0.25
0.3
20% 25% 35% 40% 45% 50%
Probability
0.1
10% 15% 30%
Since Project
257 and 432 have differing expected value
, the coefficient of va
riation

hould be the criterion by which the ri
k of the a

et i
judged. Since Project

432 ha

a
maller CV, it i
the opportunity with lower ri
k.
Rate of Return

5 10 LG 2: IntegrativeExpected Return, Standard Deviation, and Coefficient of Va

riation
a. Expected return:
=
=
n
1i
iri Pkk
Rate of Return Probability Weighted Value Expected Return
ki Pri ki x Pri ir
n
1i
i Pkk
=
=
A

et F .40 .10 .04
.10 .20 .02
.00 .40 .00
.05 .20 .01
.10 .10 .01
.04
Chapter 5 Ri
k and Return
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A

et G .35 .40 .14
.10 .30 .03
.20 .30 .06
.11
A

et H .40 .10 .04
.20 .20 .04
.10 .40 .04
.00 .20 .00
.20 .10 .02
.10
A

et G provide
the large
t expected return.
b. Standard Deviation:
=
=
n
1i

La
t

ik )kk( 2 x Pri
)kk( i )kk( i 2 P ri 2 k
A

et F .40 .04 = .36 .1296 .10 .01296
.10 .04 = .06 .0036 .20 .00072
.00 .04 = .04 .0016 .40 .00064
.05 .04 = .09 .0081 .20 .00162
.10 .04 = .14 .0196 .10 .00196
.01790 .1338

)kk( i )kk( i 2 P ri 2 k
A

et G .35 .11 = .24 .0576 .40 .02304
.10 .11 = .01 .0001 .30 .00003
.20 .11 = .31 .0961 .30 .02883
.05190 .2278
A

et H .40 .10 = .30 .0900 .10 .009
.20 .10 = .10 .0100 .20 .002
.10 .10 = .00 .0000 .40 .000
.00 .10 = .10 .0100 .20 .002
.20 .10 = .30 .0900 .10 .009
.022 .1483
Ba
ed on
tandard deviation, A

et G appear
to have the greate
t ri
k, but it m
u
t be mea
ured again
t it

expected return with the
tati
tical mea
ure coefficient of variation,
ince the
three a

et
have differing
expected value
. An incorrect conclu
ion about the ri
k of the a

et
could be
drawn u
ing only the

tandard deviation.
c.
valueexpected
)(deviation
tandard=Variation oft Coefficien
Chapter 5 Ri
k and Return
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A

et F: 345.3
04.
1338.CV ==

La
t

A

et G: 071.2
11.
2278.CV ==
A

et H: 483.1
10.
1483.CV ==
A
mea
ured by the coefficient of variation, A

et F ha
the large
t relative ri

k.
5 11 LG 2: Normal Probability Di
tribution
a. Coefficient of variation: CV = kk

Solving for
tandard deviation: .75 = k .189

k = .75 x .189 = .14175

b. 1. 58% of the outcome
will lie between  1
tandard deviation from the expecte
d value:
+l = .189 + .14175 = .33075
l = .189 .14175 = .04725
2. 95% of the outcome
will lie between  2
tandard deviation
from the expected
value:
+2 = .189 + (2 x. 14175) = .4725
2 = .189 (2 x .14175) = .0945
3. 99% of the outcome
will lie between  3
tandard deviation
from the expected
value:
+3 = .189 + (3 x .14175) = .61425
3 = .189 (3 x .14175) = .23625
c.
Probability Di
tribution
Chapter 5 Ri
k and Return
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0
10
20
30
40
50
60
0.236 0.094 0.047 0.331 0.473 0.6140.189Return

Probability

La
t

5 12 LG 3: Portfolio Return and Standard Deviation

a. Expected Portfolio Return for Each Year: kp = (wL x kL) + (wM x kM)
Expected
A

et L A

et M Portfolio Return
Year (wL x kL) + (wM x kM) kp
2004
2005
2006
2007
2008
2009

(14%
(14%
(16%
(17%
(17%
(19%

x.40
x.40
x.40
x.40
x.40
x.40

=
=
=
=
=
=

5.6%)
5.6%)
6.4%)
6.8%)
6.8%)
7.6%)

+
+
+
+
+
+

(20%
(18%
(16%
(14%
(12%
(10%

x
x
x
x
x
x

.60
.60
.60
.60
.60
.60

=
=
=
=
=
=

12.0%) = 17.6%
10.8%) = 16.4%
9.6%) = 16.0%
8.4%) = 15.2%
7.2%) = 14.0%
6.0%) = 13.6%

b. Portfolio Return:
n
kw
k
n
1j
jj
p

=
%5.15467.15
6
6.130.142.150.164.166.17kp ==+++++=
c. Standard Deviation: kp i
i
n k k
n
= =
( )
( )
2
1 1
Chapter 5 Ri
k and Return
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16
%)5.15%6.13(%)5.15%0.14(%)5.15%2.15(
%)5.15%0.16(%)5.15%4.16(%)5.15%6.17(
222
222
kp

+++
++
=

La
t

5
%)9.1(%)5.1(%)3.0(
%)5.0(%)9(.%)1.2(
222
222
kp

+++
++
=
5
%)61.3%25.2%09.0%25.0%81.0%41.4(
kp
+++++=
51129.1284.2
5
42.11
kp ===
d. The a

et
are negatively correlated.
e. Combining the
e two negatively correlated a

et
reduce
overall portfolio ri

k.
5 13 LG 3: Portfolio Analy
i

a. Expected portfolio return:
Alternative 1: 100% A

et F
%5.17
4
%19%18%17%16kp =+++=
Alternative 2: 50% A

et F + 50% A

et G
A

et F A

et G Portfolio Return
Year (wF x kF) + (wG x kG) kp
2001
2002
2003
2004

(16%
(17%
(18%
(19%

x
x
x
x

.50
.50
.50
.50

=
=
=
=

8.0%)
8.5%)
9.0%)
9.5%)

+
+
+
+

(17%
(16%
(15%
(14%

x
x
x
x

.50
.50
.50
.50

=
=
=
=

8.5%)
8.0%)
7.5%)
7.0%)

=
=
=
=

16.5%
16.5%
16.5%
16.5%

%5.16
4
66kp ==
Alternative 3: 50% A

et F + 50% A

et H
A

et F A

et H Portfolio Return
Year (wF x kF) + (wH x kH) kp
2001 (16% x .50 = 8.0%) + (14% x .50 = 7.0%) 15.0%
2002 (17% x .50 = 8.5%) + (15% x .50 = 7.5%) 16.0%
2003 (18% x .50 = 9.0%) + (16% x .50 = 8.0%) 17.0%

2004 (19% x .50 = 9.5%) + (17% x .50 = 8.5%) 18.0%

Chapter 5 Ri
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%5.16
4
66kp ==

b. Standard Deviation: kp i
i
n k k
n
= =
( )
( )
2
1 1
(1)
[ ]
14
%)5.17%0.19(%)5.17%0.18(%)5.17%0.17(%)5.17%0.16( 2222
F
+++=
[ ]
3
%)5.1(%)5.0(%)5.0(%) 1.5( 2222
F
+++=
3
%)25.2%25.0%25.0%25.2(
F
+++=
291.1667.1
3
5
F ===
(2) [ ]
14
%)5.16%5.16(%)5.16%5.16(%)5.16%5.16(%)5.16%5.16( 2222
FG
+++=
[ ]
3
)0()0()0()0( 2222
FG
+++=

La
t

0FG =
(3)
[ ]FH = + + + ( . . ( . . ( . . ( . .150% 165%) 16 0% 165%) 17 0% 165%) 18 0% 165%)
4 1
2 2 2 2
[ ]
3
%)5.1(%)5.0(%)5.0(%)5.1( 2222
FH
+++=
[ ]
3
)25.225.25.25.2(
FH
+++=
Chapter 5 Ri
k and Return
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La
t

291.1667.1
3
5
FH ===
c. Coefficient of variation: CV = kk
0738.
%5.17
291.1CVF ==
0
%5.16
0CVFG ==
0782.
%5.16
291.1CVFH ==
d. Summary:
kp: Expected Value
of Portfolio kp CVp
Alternative 1 (F) 17.5% 1.291 .0738
Alternative 2 (FG) 16.5% 0 .0
Alternative 3 (FH) 16.5% 1.291 .0782
Since the a

et
have different expected return
, the coefficient of variation

hould be u
ed to determine
the be
t portfolio. Alternative 3, with po
itively correlated a

et
, ha
the h
ighe
t coefficient of variation
and therefore i
the ri
kie
t. Alternative 2 i
the be
t choice; it i
perfectl
y negatively correlated and
therefore ha
the lowe
t coefficient of variation.

5 14 LG 4: Correlation, Ri
k, and Return

a. 1. Range of expected return: between 8% and 13%
2. Range of the ri
k: between 5% and 10%
b. 1. Range of expected return: between 8% and 13%
2. Range of the ri
k: 0 < ri
k < 10%
c. 1. Range of expected return: between 8% and 13%
2. Range of the ri
k: 0 < ri
k < 10%
5 15 LG 1, 4: International Inve
tment Return

a. Returnpe
o
= %73.2020732.500,20
250,4
500,20
500,20750,24 ===
b. 84.225,2$
hare
000,122584.2$
21.9
50.20
dollarper Pe
o

pe
o
in Priceprice Purcha
e ===
Chapter 5 Ri
k and Return
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69.512,2$
hare
000,151269.2$
85.9
75.24
dollarper Pe
o

pe
o
in Priceprice ale
S ===

La
t

c. Returnpe
o
= %89.1212887.84.225,2
85.286
84.225,2
84.225,269.512,2 ===
d. The two return
differ due to the change in the exchange rate between the pe

o and the dollar. The pe
o
had depreciation (and thu
the dollar appreciated) between the purcha
e date and
the
ale date, cau
ing a
decrea
e in total return. The an
wer in part c i
the more important of the two
return
for Joe. An inve
tor
in foreign
ecuritie
will carry exchange rate ri
k.
5 16 LG 5: Total, Nondiver
ifiable, and Diver
ifiable Ri
k
a. and b.

c. Only nondiver
ifiable ri
k

i
relevant becau
e, a


hown by the graph, diver
ifiable ri
k can be virtually eliminated through holdi
ng a portfolio of at lea
t 20

ecuritie
which are not po
itively correlated. David Talbot'
portfolio, a

um
ing diver
ifiable ri
k could
no longer be reduced by addition
to the portfolio, ha
6.47% relevant ri
k.
0
2
4
6
8
10
12
14
16
0 5 10 15 20
Number of Securitie

Diver
ifiable Nondiver
ifiable
Portfolio
Ri
k
(kp)
(%)
5 17 LG 5: Graphic Derivation of Beta
Chapter 5 Ri
k and Return
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a. Derivation of Beta
b. To e
timate
beta, the "ri
e over
run" method can be
u
ed:
Beta =
Ri
e
Run
=
Y
X
Taking the
point

hown on the
graph:
75.
4
3
48
912 ==

X
Y=A Beta =

La
t

33.1
3
4
1013
2226
X
Y=B Beta ==
=

12
8
4
0
4
8
12
16
20
24
28
32
16 12 8 4 0 4 8 12 16
A

et B
A

et A
Market Return
A

et Return %
b =
lope = 1.33
b =
lope = .75
A financial calculator with
tati
tical function
can be u
ed to perform linear
regre

ion analy
i
. The beta
(
lope) of line A i
.79; of line B, 1.379.
c. With a higher beta of 1.33, A

et B i
more ri
ky. It
return will move 1.33
time
for each one point the
market move
. A

et As return will move at a lower rate, as indicated by its bet
a coefficient of .75.
5-18 LG 5: Interpreting Beta
Effect of change in market return on asset with beta of 1.20:
a. 1.20 x (15%) = 18.0% increase
b. 1.20 x (-8%) = 9.6% decrease
c. 1.20 x (0%) = no change
d. The asset is more risky than the market portfolio, which has a beta of 1. Th
e higher beta makes the
return move more than the market.
5-19 LG 5: Betas
a. and b.
Increase in Expected Impact Decrease in Impact on
Asset Beta Market Return on Asset Return Market Return Asset Return
A 0.50 .10 .05 -.10 -.05
B 1.60 .10 .16 -.10 -.16
C - 0.20 .10 -.02 -.10 .02
D 0.90 .10 .09 -.10 -.09

c. Asset B should be chosen because it will have the highest increase in return.
d. Asset C would be the appropriate choice because it is a defensive asset, movi
ng in opposition to the
market. In an economic downturn, Asset Cs return is increasing.
5-20 LG 5: Betas and Risk Rankings
a. Stock Beta
Most risky B 1.40
A 0.80
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Least risky C -0.30

Last

b. and c. Increase in Expected Impact Decrease in Impact on

Asset Beta Market Return on Asset Return Market Return Asset Return
A 0.80 .12 .096 -.05 -.04
B 1.40 .12 .168 -.05 -.07
C - 0.30 .12 -.036 -.05 .015
d. In a declining market, an investor would choose the defensive stock, stock C.
While the market declines,
the return on C increases.
e. In a rising market, an investor would choose stock B, the aggressive stock.
As the market rises one point,
stock B rises 1.40 points.
5-21 LG 5: Portfolio Betas: bp =
=

n
1j
jj bw
a.
Portfolio A Portfolio B
Asset Beta wA wA x bA wB wB x bB
1
2
3
4
5

1.30 .10 .130 .30 .39

0.70 .30 .210 .10 .07
1.25 .10 .125 .20 .25
1.10 .10 .110 .20 .22
.90 .40 .360 .20 .18
bA = .935 bB = 1.11
b. Portfolio A is slightly less risky than the market (average risk), while Port
folio B is more risky than the
market. Portfolio Bs return will move more than Portfolio As for a given increa
se or decrease in market
return. Portfolio B is the more risky.
5-22 LG 6: Capital Asset Pricing Model (CAPM): kj = RF + [bj x (km - RF)]
Case kj = RF + [bj x (km - RF)]
A
B
C
D

8.9% = 5% + [1.30 x (8% - 5%)]

12.5% = 8% + [0.90 x (13% - 8%)]
8.4% = 9% + [- 0.20 x (12% - 9%)]
15.0% = 10% + [1.00 x (15% - 10%)]

E 8.4% = 6% + [0.60

x (10% - 6%)]

5-23 LG 6: Beta Coefficients and the Capital Asset Pricing Model

To solve this problem you must take the CAPM and solve for beta. The resulting
model is:
Fm
F
Rk
RkBeta
=
a. 4545.
%11
%5
%5%16
%5%10Beta ==
=
b. 9091.
%11
%10
%5%16
%5%15Beta ==
=
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k and Return
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c. 1818.1
%11
%13
%5%16
%5%18Beta ==
=

La
t

d. 3636.1
%11
%15
%5%16
%5%20Beta ==
=
e. If Katherine i
willing to take a maximum of average ri
k then
he will be ab
le to have an expected return
of only 16%. (k = 5% + 1.0(16%
5%) = 16 %.)
5 24 LG 6: Manipulating CAPM: kj = RF + [bj x (km
a. kj = 8% + [0.90 x (12%
kj = 11.6%
b. 15% = RF + [1.25 x (14%
RF = 10%
c. 16% = 9% + [1.10 x (km
km = 15.36%
d. 15% = 10% + [bj x (12.5%
bj = 2

8%)]
RF)]

9%)]
10%)

RF)]

5 25 LG 1, 3, 5, 6: Portfolio Return and Beta

a. bp = (.20)(.80)+(.35)(.95)+(.30)(1.50)+(.15)(1.25) = .16+.3325+.45+.1875=1.13
b. %8
000,20$
600,1$
000,20$
600,1$)000,20$000,20($kA ==+=
%86.6
000,35$
400,2$
000,35$
400,1$)000,35$000,36($kB ==+=
%15
000,30$
500,4$
000,30$
0)000,30$500,34($kC ==+=
%5.12
000,15$
875,1$
000,15$
375$)000,15$500,16($kD ==+=
c. %375.10
000,100$
375,10$
000,100$
375,3$)000,100$000,107($kP ==+=
d. kA = 4% + [0.80 x (10%

4%)] = 8.8%

kB = 4% + [0.95 x (10%

4%)] = 9.7%

kC = 4% + [1.50 x (10%

4%)] = 13.0%

kD = 4% + [1.25 x (10% 4%)] = 11.5%

Chapter 5 Ri
k and Return
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135

La
t

e. Of the four inve
tment
, only C had an actual return which exceeded the CAPM
expected return (15%
ver
u
13%). The underperformance could be due to any un
y
tematic factor which
would have cau
ed
the firm not do a
well a
expected. Another po

ibility i
that the firm'
cha
racteri
tic
may have changed

uch that the beta at the time of the purcha
e over
tated the true value of beta
that exi
ted during that year.
A third explanation i
that beta, a
a
ingle mea
ure, may not capture all of th
e
y
tematic factor
that
cau
e the expected return. In other word
, there i
error in the beta e
timate.

5 26 LG 6: Security Market Line, SML

a., b., and d.
Security Market Line
0
2
4
6
8
10
12
14
16
0 0.2 0.4 0.6 0.8 1 1.2 1.4
S
Ri

A
K
B
Ri
k premium

Market Ri
k
Required Rate
of Return %

Nondiver
ifiable
c. kj RF + [bj x (km

RF)]

A

et A
kj = .09 + [0.80 x (.13 .09)]
kj = .122
A

et B
kj = .09 + [1.30 x (.13 .09)]
kj = .142
d. A

et A ha
a
maller required return than A

et B becau
e
A

et A ver
u
1.30 for A

et B. The market ri
k premium
lower than A

et B'
(14.2% 9% = 5.2%).
Ri
k (Beta)
aved and edited by Md.Kaw
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it i
le

ri
ky, ba
ed on the beta of 0.80 for
for A

et A i
3.2% (12.2% 9%), which i

Chapter 5 Ri
k and Return
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t
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5 27 LG 6: Shift
in the Security Market Line
a., b., c., d.
Security Market Line

b. kj = RF + [bj x (km
ore at ww

RF)]

kA = 8% + [1.1 x (12%
8%)]
kA =
8%
+ 4.4%
kA =
12.4%
c. kA = 6% + [1.1
kA = 6% + 4.4% 0
2
4
8
10
12
14
16
18
20
0 0.2 0.4 0.6 0.8
A

et A
A

et A
SMLd
SMLa
SMLc
Required
Return
(%)
6
kA = 10.4%
Nondiver
ifiable
d. kA = 8% + [1.1
kA = 8% + 5.5%
kA = 13.5%

x (10%

6%)]

1 1.2 1.4 1.6 1.8 2

Ri
k (Beta)
x (13% 8%)]

e. 1. A decrea
e in inflationary expectation
reduce
the required return a

ho

wn in the parallel downward

hift of the SML.
2. Increa
ed ri
k aver
ion re
ult
in a
teeper
lope,
ince a higher return wou
ld be required for each level
of ri
k a
mea
ured by beta.

5 28 LG 5, 6: Integrative Ri
k, Return, and CAPM

a. Project kj = RF + [bj x (km

RF)]

A
B
C
D
E

kj
kj
kj
kj
kj

=
=
=
=
=

9%
9%
9%
9%
9%

+
+
+
+
+

[1.5
[.75
[2.0
[ 0
[( .5)

x (14%
x (14%
x (14%
x (14%
x (14%

9%)] = 16.5%
9%)] = 12.75%
9%)] = 19.0%
9%)] = 9.0%
9%)] = 6.5%

b. and d.
Security Market Line
SMLb
SMLd
Required
Rate of
Return
(%)
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k and Return
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c. Project A i
150% a
re
pon
ive
a
the market.
Project B i
75% a
re
pon
ive a

the market.
Project C i
twice a
re
pon
ive
a
the market.
Project D i
unaffected by market
movement.
Project E i
only half a

re
pon
ive a
the market, but
move
in the oppo
ite direction a

the market.

La
t

d. See graph for new SML.

kA = 9% + [1.5 x (12% 9%)]
kB = 9% + [.75 x (12% 9%)]
kC = 9% + [2.0 x (12% 9%)]
kD = 9% + [0
x (12%
9%)] = 9.00%
kE = 9% + [ .5 x (12% 9%)]
0
2
4
6
8
10
12
14
16
18
20
0.5 0 0.5 1 1.5 2
Nondiver
ifiable Ri
k (Beta)
e. The
teeper
lope of SMLb indicate
a higher ri
k premium than SMLd for the
e
market condition
. When
inve
tor ri
k aver
ion decline
, inve
tor
require lower return
for any given r
i
k level (beta).
Chapter 5 Ri
k and Return
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Chapter 5 Ca
e

Analyzing Ri
k and Return on Charger
Product
' Inve
tment

Thi
ca
e require

tudent
to review and apply the concept of the ri
k return t
rade off by analyzing two po

ible
a

et inve
tment
u
ing
tandard deviation, coefficient of variation, and CAPM.
a.
Expected rate of return:
1t
t1tt
t
P
)CPP(k

+=
A

et X:
Ca
h Ending Beginning Gain/ Annual Rate
Year Flow (Ct) Value (Pt) Value (Pt 1) Lo

of Return
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

$1,000 $22,000 $20,000 $2,000 15.00%

1,500 21,000 22,000
1,000 2.27
1,400 24,000 21,000 3,000 20.95
1,700 22,000 24,000 2,000 1.25
1,900 23,000 22,000 1,000 13.18
1,600 26,000 23,000 3,000 20.00
1,700 25,000 26,000
1,000 2.69
2,000 24,000 25,000 1,000 4.00
2,100 27,000 24,000 3,000 21.25
2,200 30,000 27,000 3,000 19.26

Average expected return for A

et X = 11.74%

A

et Y:
Ca
h Ending Beginning Gain/ Annual Rate
Year Flow (Ct) Value (Pt) Value (Pt 1) Lo

of Return
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

$1,500 $20,000 $20,000 $0 7.50%

1,600 20,000 20,000 0 8.00
1,700 21,000 20,000 1,000 13.50
1,800 21,000 21,000 0 8.57
1,900 22,000 21,000 1,000 13.81
2,000 23,000 22,000 1,000 13.64
2,100 23,000 23,000 0 9.13
2,200 24,000 23,000 1,000 13.91
2,300 25,000 24,000 1,000 13.75
2,400 25,000 25,000 0 9.60

Average expected return for A

et Y = 11.14%

b.
k =
=

n
1i
2
i )1n()kk(

A

et X:
Return Average
Year ki Return, k )kk( i )kk( i 2
Chapter 5 Ri
k and Return
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1994 15.00% 11.74% 3.26% 10.63%
1995 2.27 11.74 9.47 89.68
1996 20.95 11.74 9.21 84.82
1997
1.25 11.74 12.99 168.74
1998 13.18 11.74 1.44 2.07
1999 20.00 11.74 8.26 68.23
2000 2.69 11.74 9.05 81.90
2001 4.00 11.74 7.74 59.91
2002 21.25 11.74 9.51 90.44
2003 19.26 11.74 7.52 56.55
712.97
%90.822.79
110
97.712
x ===
76.
%74.11
90.8CV ==
A

et Y
Return Average
Year ki Return, k )kk( i )kk( i 2
1994 7.50% 11.14% 3.64% 13.25%
1995 8.00 11.14 3.14 9.86
1996 13.50 11.14 2.36 5.57
1997 8.57 11.14 2.57 6.60
1998 13.81 11.14 2.67 7.13
1999 13.64 11.14 2.50 6.25
2000 9.13 11.14 2.01 4.04
2001 13.91 11.14 2.77 7.67
2002 13.75 11.14 2.61 6.81
2003 9.60 11.14 1.54 2.37
69.55
%78.273.7
110
55.69
Y ===
25.
%14.11
78.2CV ==
c. Summary Stati
tic
:
A

et X A

et Y
Expected Return 11.74% 11.14%
Standard Deviation 8.90% 2.78%
Coefficient of Variation .76 .25

La
t

Comparing the expected return
calculated in part a, A

et X provide
a return o

f 11.74 percent, only

lightly above the return of 11.14 percent expected from A

et Y. The higher
t
andard deviation and
coefficient of variation of Inve
tment X indicate
greater ri
k. With ju
t thi

information, it i
difficult to
Chapter 5 Ri
k and Return
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La
t

aved and edited by Md.Kaw
ar Siddiqui 140
determine whether the .60 percent difference in return i
adequate compen
ation
for the difference in ri
k.
Ba
ed on thi
information, however, A

et Y appear
to be the better choice.
d. U
ing the capital a

et pricing model, the required return on each a

et i
a

follow
:
Capital A

et Pricing Model: kj = RF + [bj x (km
A

et RF + [bj x (km
X 7% + [1.6 x (10%
Y 7% + [1.1 x (10%

RF)]

RF)] = kj
7%)] = 11.8%
7%)] = 10.3%

From the calculation
in part a, the expected return for A

et X i
11.74%, comp
ared to it
required return
of 11.8%. On the other hand, A

et Y ha
an expected return of 11.14% and a req
uired return of only
10.8%. Thi
make
A

et Y the better choice.
e. In part c, we concluded that it would be difficult to make a choice between X
and Y becau
e the additional
return on X may or may not provide the needed compen
ation for the extra ri
k.
In part d, by calculating a
required rate of return, it wa
ea
y to reject X and
elect Y. The required ret
urn on A

et X i
11.8%, but
it
expected return (11.74%) i
lower; therefore A

et X i
unattractive. For A


et Y the rever
e i
true,
and it i
a good inve
tment vehicle.
Clearly, Charger Product
i
better off u
ing the
tandard deviation and coeffic
ient of variation, rather than
a
trictly
ubjective approach, to a

e

inve
tment ri
k. Beta and CAPM, howev
er, provide a link
between ri
k and return. They quantify ri
k and convert it into a required retu
rn that can be compared to
the expected return to draw a definitive conclu
ion about inve
tment acceptabili
ty. Contra
ting the
conclu
ion
in the re
pon
e
to que
tion
c and d above
hould clearly demon
tra
te why Junior i
better off
u
ing beta to a

e

ri
k.
f. (1) Increa
e in ri
k free rate to 8 % and market return to 11 %:
A

et RF + [bj x (km
X 8% + [1.6 x (11%
Y 8% + [1.1 x (11%

RF)] = kj
8%)] = 12.8%
8%)] = 11.3%

(2) Decrea
e in market return to 9 %:

A

et RF + [bj x (km

RF)] = kj

X 7% + [1.6 x (9% 7%)] = 10.2%

Y 7% + [1.1 x (9% 7%)] = 9.2%
In
ituation (1), the required return ri
e
for both a

et
, and neither ha
an
expected return above the firm'

required return.
With
ituation (2), the drop in market rate cau
e
the required return to decrea

e
o that the expected
return
of both a

et
are above the required return. However, A

et Y provide

a larger return compared
to it
required return (11.14 9.20 = 1.94), and it doe

o with le

ri
k than
A

et X.