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# Risk and Return - DOC

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```									Risk and Return Case 7

Peachtree Securities, Inc. (A)
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which make up the S&P 500 index. Donahue's final preparatory step was to outline some questions that she believed to be relevant to the task at hand. See if you can answer the questions she developed. Table 1 Estimated Total Returns 1-Year T-Bond
5.8% 5.8 5.8 5.8 5.8

State of the Economy
Recession Below average Average Above average Boom

Probability
0.10 0.20 0.40 0.20 0.10

Estimated Total Returns Gold S&P 500 TECO Hill Fund
-6.0% 2.0 10.0 14.0 20.0 16.0% 13.0 9.0 4.0 - 6.0 -9.0% 2.0 11.0 15.0 18.0

Questions
1. Calculate the expected rate of return on each of the four alternatives listed in Table 1. Based solely on expected returns, which of the potential investments appears best?

2.

Now calculate the standard deviations for the four alternatives. What type of risk do these statistics measure?

3.

Suppose an investor forms a stock portfolio by investing \$10,000 in Gold Hill and \$10,000 in TECO.

a. What would be the portfolio's expected rate of return and standard deviation? b. Explain the differences between total risk, diversifiable (company-specific) risk, and market risk. c. Assume that you choose to hold a single stock portfolio. Should you expect to be compensated for all of the risk that you bear?

4.

Plot the Security Market Line. (Hint: Use Table 1 data to obtain the risk-free rate and the required rate of return on the market.) What is the required rate of return on TECO's stock using Value Line's beta estimate of 0.6? Based on the CAPM analysis, should investors buy TECO stock?

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