Nama : Arini Riska Tri Suryandari

NIM : 20/454848/EK/22812

Chapter 7

7-4 (Calculating rates of return) Quick Learning PLC makes toys for young children. Last year,
their share were selling at $26. By the end of year they were being traded at $22. If the firm
has paid a dividend of $5 during the year, what rate of return would have been earned if this
stock had been purchased exactly one year ago? What would the return be if Quick Learning
PLC had not paid any cash devidend?

Answer :

• Formula
𝐶𝑎𝑠ℎ 𝑅𝑒𝑡𝑢𝑟𝑛
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 =
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒
𝐸𝑛𝑑𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 + 𝐷𝑒𝑣𝑖𝑑𝑒𝑛𝑑 − 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒
=
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒

• What rate of return would have been earned if this stock had been purchased
exactly one year ago?
22 + 5 − 26
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 =
26
1
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝑎𝑡𝑎𝑢 0,038 𝑎𝑡𝑎𝑢 3,8%
26

• What would the return be if Quick Learning PLC had not paid any cash devidend?
The return will be $-4
22 − 26
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 =
26
4
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 = − 𝑎𝑡𝑎𝑢 0,153 𝑎𝑡𝑎𝑢 − 15,3%
26
7-10 (Solving a comprehensive problem) Use the following end-of-year price data to answer
the following questions for the Harris and Pinwheel companies.

Time Harris Pinwheel

1 $10 $20
2 $8 $32
3 $12 $28
4 $15 $27

a. Compute the annual rates of return for each time period and for both firms.
Answer :

Time Rate of Return for Harris Rate of Return of Pinwheel

1-2 $8 − $10 2 $32 − $20 12

= − = = 0,6 𝑎𝑡𝑎𝑢 60%
$10 10 $20 20
= − 0,2 𝑎𝑡𝑎𝑢 − 20%

2-3 $12 − $8 4 $28 − $32 4

= = 0,5 𝑎𝑡𝑎𝑢 50% = −
$8 8 $32 32
= −0,125 𝑎𝑡𝑎𝑢
− 12,5%

3-4 $15 − $12 3 $27 − $28 1

= = 0,25 𝑎𝑡𝑎𝑢 25% = −
$12 12 $28 28
= −0,035 𝑎𝑡𝑎𝑢 − 3,5%

b. Calculate both arithmatic and geomethric mean rates of return for the entire three -
year period using your annual rates of return from part a.
Answer :
• Arithmetic Average rate of return
For Harris Company,
−20% + 50% +25%
=
3
55%
=
3

= 18,3%
 For Pinwheel Company

60% − 12,5% − 3,5%

=
3

44%
=
3

= 14,6%

• Geometric Average rate of return

Formula
1/𝑛
GAR = [(1 + 𝑟𝑦𝑒𝑎𝑟 1 ) 𝑥 (1 + 𝑟𝑦𝑒𝑎𝑟 2 )𝑥 . . . 𝑥 (1 + 𝑟𝑦𝑒𝑎𝑟 𝑛 )] − 1

For Harris Company,

GAR = [(1 − 0,20) 𝑥 (1 + 0,50) 𝑥 (1 + 0,25)] 1/3 − 1
GAR = [(0,80) 𝑥 (1,50) 𝑥 (1,25)]1/3 − 1
GAR = [1,50] 1/3 − 1
GAR = 1,14 – 1
GAR = 0,14

For Pinwheel Company,

GAR = [(1 + 0,60) 𝑥 (1 − 0,125) 𝑥 (1 − 0,035) ]1/3 − 1
GAR = [(1,60) 𝑥 (0,875) 𝑥 (0,965)]1/3 − 1
GAR = [1,351] 1/3 − 1
GAR = 1,105 – 1
GAR = 0,105

c. Compute a three-year rate of return spanning the entire period (i.e., using the
beginning price for Period 1 and the ending price for Period 4)
Answer :
For Harris Company,
 15−10 5
= = 0,5 atau 50%
10 10

For Pinwheel Company,

27−20 7
= = 0,35 atau 35%
20 20

d. Because the rate of return calculated in part c is a three-year rate of return, convert
it to annual rate of return using the following equation :
( 1 + 𝑇ℎ𝑟𝑒𝑒 𝑌𝑒𝑎𝑟 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛) = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛) 3
Answer :
For Harris Company,
( 1 + 0,5) = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛) 3
1,5 = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛) 3
3
√1,5 = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛)
1,14 = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛)
1,14 − 1 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛
𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = 0,14 atau 14%

For Pinwheel Company,

( 1 + 0,35) = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛) 3
1,35 = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛) 3
3
√1,35 = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛)
1,105 = ( 1 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛)
1,105 − 1 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛
𝐴𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = 0,105 atau 10,5%

e. How is the annual rate of return calculated in part d related to the geometric rate of
return? When you are evaluating the performance of an investment that has been
held for several years, what type of average rate of return (arithmetic or geometric)
should you use? Why?
Answer :
Perhitungan part b dan part d memiliki hasil perhitungan yang sama. Perbedaannya
hanya pada perhitungan part b menggunakan data rate of return pertahun sedangkan
 part d menggunakan rekap rate of return selama 3 tahun. Tipe perhitungan average
rate of return yang digunakan untuk mengevaluasi kinerja investasi jangka panjang
adalah geomethric rate of return karena perhitungan dilakukan pada rate yang sama
untuk semua periodenya.

Chapter 8

8-5 (Computing the portfolio expected rate of return) (Related to Checkpoint 8.1 on page
257) Penny Francis inherited a $200,000 portfolio of investments from her grandparents
when she turned 21 years of age. The portfolio is comprised of treasury bills and stock in
Ford (F) and Harley Davidson (HOG) :

Expected Return $ Value

Treasury Bills 4,5% $80,000
Ford (F) 8% $60,000
Harley Davidson (HOG) 12% $60,000

a. Based on the current portfolio composition and the expected rate of return,
what is the expected rate of return for Penny’s portfolio?
Answer :

Expected Return Weight Product

Treasury Bills 4,5% $80,000 4,5% x 0,4 = 1,8%
= 0,4
200,000

Ford (F) 8% $60,000 8% x 0,3 = 2,4%

= 0,3
200,000

Harley Davidson (HOG) 12% $60,000 12% x 0,3 = 3,6%

= 0,3
200,000

Sum = 7,8%

b. If Penny wants to increase her expected portfolio rate of return, she can increase
the allocated weight of the portfolio she has invested in stock (Ford and Harley
 Davidson) and decrease her holdings of Treasury bills. If Penny moves all her
money out of Treasury Bills and splits evenly between the two stock, what will be
her expected rate of return?
Answer :
Weight of Treasury bills is 0,4 and will be splited evenly between the two stock.
So, each stock will get +0,2.

Expected Return Weight Product

Ford (F) 8% 0,3 + 0,2 = 0,5 8% x 0,5 = 4%
Harley Davidson
12% 0,3 + 0,2 = 0,5 12% x 0,5 = 6%
(HOG)
Sum = 12%

c. If Penny does move money out of Treasury bills and into two stocks, she will reap
a higher expected portfolio return, so why would anyone want to hold Treasury
bills in their portfolio?
Answer :
Treasury bills menawarkan expected rate of return yang lebih rendah
dibandingkan dengan alternatif investasi lainnya. Namun, treasury bills
menawarkan investasi yang risk free atau bebas risiko sehingga investor tidak
perlu khawatir akan kerugian investasi.

8-23 (Calculating the portfolio beta and expected return) You are putting together a
portfolio made up of four different stocks. However, you are considering two possible
weightings :

Portfolio Weightings
Asset Beta
First Portfolio Second Portfolio
A 2.5 10% 40%
B 1.0 10% 40%
C 0.5 40% 10%
D -1.5 40% 10%
a. What is the beta on each portfolio?
Answer :
𝛽𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 = 𝑊1 𝛽1 + 𝑊2 𝛽2 + . . . + 𝑊𝑛 𝛽𝑛

Beta Portfolio
Asset Beta
First Portfolio Second Portfolio
A 2.5 0.1 x 2.5 = 0.25 0.4 x 2.5 = 1
B 1.0 0.1 x 1.0 = 0.1 0.4 x 1.0 = 0.4
C 0.5 0.4 x 0.5 = 0.2 0.1 x 0.5 = 0,05
D -1.5 0.4 x -1.5 = -0.6 0.1 x -1.5 = -0,15
Sum = -0.05 Sum = 1.3

b. Which portfolio is riskier?

Answer :
Menurut perhitungan risiko dengan menggunakan beta, portofolio yang lebih berisiko
adalah portofolio kedua karena memiliki nilai beta yang lebih tinggi yaitu 1.3 (>1).
Semakin tinggi beta saham maka risiko juga semakin besar karena return lebih sensitif
dengan perubahan IHSG.

c. If the risk-free rate of interest is 4 percent and the market risk premium is 5 percent,
what rate of return do you expect to earn from each of the portfolios?
Formula :
E(rasset ) = rf + 𝛽asset [E(rmarket )-rf ]
Given :
Risk free = 4%
Market risk premium = 5%
Anwer :
For the first portfolio,
E(rasset ) = 4% + (-0.05)(5%)
E(rasset ) = 4% + (-0.25)
E(rasset ) = 3.75%
For the second portfolio,
E(rasset ) = 4% + (1.3)(5%)
E(rasset ) = 4% + (6.5)
E(rasset ) = 10.5%