A mini case:
Suppose an investor would like to invest in a portfolio of two stocks, Goldman and Landry. She wants some advice from a financial analyst like you. She wants to know about the risk and return of her investment. You would like to analyse the risk and return for both companies using (available) last 7 years' historical data. Solve the following problems in a file in spreadsheet, then save and submit it.
Hypothetical data for Goldman Industries's and Landry Incorporated's stock prices and dividends, along with the Market Index, are shown below. Stock prices are reported for December 31 of each year, and dividends reflect those paid during the year.
Table: Data as given in the problem are shown below:
|
Year
|
Goodman Industries
|
Landry Incorporated
|
Market Index
|
|
Stock Price
|
Dividend
|
Stock Price
|
Dividend
|
Includes Divs.
|
|
2016
|
$25.88
|
$1.73
|
$73.13
|
$4.50
|
17,495.97
|
|
2015
|
$22.13
|
$1.59
|
$78.45
|
$4.35
|
13,178.55
|
|
2014
|
$24.75
|
$1.50
|
$73.13
|
$4.13
|
13,019.97
|
|
2013
|
$16.13
|
$1.43
|
$85.88
|
$3.75
|
9,651.05
|
|
2012
|
$17.06
|
$1.35
|
$90.00
|
$3.38
|
8,403.42
|
|
2011
|
$11.44
|
$1.28
|
$83.63
|
$3.00
|
7,058.96
|
|
2010
|
$11.00
|
$1.15
|
$80.50
|
$2.75
|
7,001.15
|
a. Use the data given to calculate annual returns for Goodman, Landry, and the Market Index, and then calculate average returns over the five-year period. (Hint: Remember, returns are calculated by subtracting the beginning price from the ending price to get the capital gain or loss, adding the dividend to the capital gain or loss, and dividing the result by the beginning price. Assume that dividends are already included in the index. Also, you cannot calculate the rate of return for 2010 because you do not have 2009 data.)
We now calculate the rates of return for the two companies and the market index.
b. Calculate the standard deviation of the returns for Goodman, Landry, and the Market Index. (Hint: Use the sample standard deviation formula given in the chapter, which corresponds to the STDEV function in Excel.)
c. Construct a scatter diagram graph that shows Goodman's and Landry' returns on the vertical axis and the Market Index's returns on the horizontal axis.
d. Estimate Goodman's and Landry's betas as the slopes of regression lines with stock returns on the vertical axis (y-axis) and market return on the horizontal axis (x-axis). (Hint: use Excel's SLOPE function.) Are these betas consistent with your graph?
e. The risk-free rate on long-term Treasury bonds is 6.04%. Assume that the market risk premium is 5%. What is the expected return on the market? Now use the SML equation to calculate the two companies' required returns.
f. If you formed a portfolio that consisted of 50% Goodman stock and 50% Landry stock, what would be its beta and its required return?
g. Suppose an investor wants to include Goodman Industries' stock in his or her portfolio. Stocks A, B, and C are currently in the portfolio, and their betas are 0.769, 0.985, and 1.423, respectively. Calculate the new portfolio's required return if it consists of 25% of Goodman, 15% of Stock A, 40% of Stock B, and 20% of Stock C.