BM2213

NAME: DATE: SCORE: ____________

Risk and Rates of Return (30 points: 6 items x 5 points)

Read and analyze each given scenario and provide what is asked. Show your complete solutions.

Realized Rates of Returns:

Stocks A and B have the following historical returns:
Year Stock A's Returns, rA Stock B's Returns, rB
2x15 -24.25% 5.50%
2x16 18.50% 26.73%
2x17 38.67% 48.25%
2x18 14.33% -4.50%
2x19 39.13% 43.86%

a. Calculate the average rate of return for each stock during the period 2x15 through 2x19. Assume that
someone held a portfolio consisting of 50% of Stock A and 50% of Stock B. What would have been the
realized rate of return on the portfolio in each year from 2x15 through 2x19? What would have been the
average return on the portfolio during that period?

b. Calculate the standard deviation of returns for each stock.

c. Assume the risk-free rate during this time was 3.5%. Using average returns, what are the Sharpe ratios for
Stocks A and B over this time period?

Beta and the Required Rate of Return:

ECRI Corporation is a holding company with four (4) main subsidiaries. The percentage of its capital invested
in each of the subsidiaries (and their respective betas) are as follows:
Subsidiary Percentage of Capital Beta
Electric Utility 60% 0.70
Cable Company 25% 0.90
Real Estate Development 10% 1.30
International/Special Projects 5% 1.50

a. What is the holding company’s beta?

b. If the risk-free rate is 4% and the market risk premium is 5%, what is the holding company’s required rate
of return?

c. ECRI is considering a change in its strategic focus; it will reduce its reliance on the electric utility subsidiary,
so the percentage of its capital in this subsidiary will be reduced to 50%. At the same time, it will increase
its reliance on the international/special projects division, so the percentage of its capital in that subsidiary
will rise to 15%. What will the company’s required rate of return be after these changes?

GRADING RUBRIC:
CRITERIA POINTS
Complete solution with correct answer 5
Half of the solution is correct. 3
First major step of the solution is correct. 1

08 Performance Task 1 *Property of STI

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