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Askari Capital staff has estimated the probability values for the state of the economy, and also
estimated the corresponding rate of return on each alternative under each state of the economy.
Nescom. is technology firm, Nawab collects past-due debts, and PK_Steel manufactures steel
products. Askari capital also maintains a “market portfolio” that owns a market-weighted
fraction of all publicly traded stocks on Pakistan exchange market; you can invest in that
portfolio and thus obtain average stock market results. Given the situation described, answer the
following questions:
1. Why is the T-bill’s return independent of the state of the economy? Do T-bills promise a
completely risk-free return? Explain?
2. Why are Nescom returns expected to move with the economy, whereas Nawab’s are
expected to move counter to the economy?
3. Calculate the expected rate of return on each alternative.
4. You should recognize that basing a decision solely on expected returns is appropriate
only for risk neutral individuals. Your client is risk-averse, the riskiness of each
alternative is an important aspect of the decision. One possible measure of risk is the
standard deviation of returns. Calculate this value for each alternative.
5. What type of risk is measured by the standard deviation?
6. Suppose you suddenly remembered that the coefficient of variation (CV) is generally
regarded as being a better measure of stand-alone risk than the standard deviation when
the alternatives being considered have widely differing expected returns. Calculate the
CVs and interpret the results.
7. Suppose you created a two-stock portfolio by investing Rupees 50,000 in Nescom and
Rupees 50,000 in Nawab. Now Calculate the expected return of portfolio, the standard
deviation of portfolio and the coefficient of variation of portfolio. Also write about how
the riskiness of this two-stock portfolio compares with the riskiness of the individual
stocks if they were held in isolation?
8. Assume that the expected rates of return and the beta coefficients of the alternatives
supplied by an independent analyst are as follows:
What is a beta coefficient, and how are betas used in risk analysis?
Do the expected returns appear to be related to each alternative’s market risk?
Is it possible to choose among the alternatives on the basis of the information developed
thus far?
9. Assumes that the risk-free rate is 3.0%, and risk premium is expected return on market
portfolio less risk.
Write out the security market line (SML) equation; use it to calculate the required
rate of return on each alternative?
How do the expected rates of return compare with the required rates of return?
Identify the undervalued companies?
Ans 5: Investment type risks are more associated with the standard deviation, higher the standard
deviation higher the risk for investment. All types of investments for example stock market,
commodities market, mutual funds, bonds markets etc are the typical markets for investments involving
risks and standard deviation. In contributing, standard deviation is utilized as a pointer of market
instability and in this manner of danger. The more capricious the value activity and the more extensive
the reach, the more noteworthy the danger. Reach bound protections, or those that don't wander a
long way from their methods, are not viewed as an incredible danger. That is on the grounds that it
tends to be expected—with relative assurance—that they keep on carrying on similarly. A security with
an exceptionally enormous exchanging range and an inclination to spike, turn around out of nowhere, or
hole is a lot more hazardous, which can mean a bigger misfortune. However, recall, hazard isn't really an
awful thing in the venture world. The more dangerous the security, the more noteworthy potential it
has for payout.
Ans 8:
Beta is a factual proportion of the instability of a stock versus the general market. It's by and
large utilized as both a proportion of deliberate danger and an exhibition measure. The market
is depicted as having a beta of 1. The beta for a stock portrays how much the stock's value
moves contrasted with the market. Beta is a proportion of a stock's instability comparable to
the general market. By definition, the market, for example, the S&P 500 Index, has a beta of 1.0,
and individual stocks are positioned by the amount they digress from the market. A stock that
swings more than the market over the long run has a beta above 1.0. In the event that a stock
moves not exactly the market, the stock's beta is under 1.0. High-beta stocks should be more
dangerous however give better yield potential; low-beta stocks present less danger yet in
addition lower returns. We can calculate or derive from graph using slope as well
The normal or expected returns are identified with every elective's market hazard - that is, the
higher the elective's pace of return the higher its beta. Likewise, note that t-bills have 0 danger.
It is not possible to choose among the alternatives on the basis of the information
developed thus far because we do not yet know the required rate of return on these
alternatives and compare them with their expected returns.