Corporate and International Finance (N1563)
Seminar 4 (questions)
SHORT ANSWERS | PROBLEMS
1) Explain the term efficient portfolio.
2) Briefly explain the term security market line.
3) Briefly explain the capital asset pricing model.
4) Briefly explain how the beta of a stock is estimated.
5) Briefly explain the difference between beta as a measure of risk and variance as a measure of risk.
6) A project has a beta of 1.24, the risk-free rate is 3.8%, and the market rate of return is 9.2%. What is the project's expected rate of return?
7) What is the standard deviation of returns of a portfolio that produced returns of 10%, 15%, 25%, and 30%? Consider these returns as complete population.
8) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their stock returns for the past three years were: FC: -5%, 15%, 20%; MC: 8%, 8%, 20%. If FC and MC are combined into a portfolio with 50% of the funds invested in each stock, calculate the expected return on the portfolio.
9) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their stock returns for the past three years were: FC: -5%, 15%, 20%; MC: 8%, 8%, 20%. What is the standard deviation of a portfolio with 50% of the funds invested in FC and 50% in MC? Note that the correlation coefficient between FC and MC is +0.655. Consider these returns as sample population.
Students must complete the following homework and share the findings with the rest of the class (please spend at least 10 minutes at the end of the seminar to go over the homework).
Homework 1
Check the instructions on Canvas on how to construct the Efficient Frontier (EF) using two stocks: Tesco and Experian. You should choose different stocks (from FTSE100) to construct your portfolio and the EF. Follow the steps shown in the video tutorial in Canvas.
You should construct the EF and be able to interpret the graph properly. Address the following two questions:
1. Identify the combination of these two stocks that provide you with the maximum portfolio return for the least possible risk.
2. Identify the area that we call an efficient frontier, and why would you suggest someone invest only in that portion of the frontier?
Homework 2
Check the spreadsheet on Canvas on how to measure the Beta and Jensen alpha of Tesco. You should choose a different stock(s) (from FTSE100) to measure your stock’s beta and Jensen Alpha.
Address the following two questions:
1. How do you interpret the beta of your stock? Does it go up/down with the market index?
2. How do you interpret the R-squared of your regression? How much risk is attributed to the firm-specific risk?
3. What is your Jensen Alpha? How do you interpret your stock’s Jensen Alpha? Did your stock do better/worse than expected during the regression/sample period?