Task: Risk, Return, and the Capital Asset Pricing Model
As a first day intern at Tri-Star Management Incorporated the CEO asks you to analyze the following information pertaining to two common stock investments, Tech.com Incorporated and Sam’s Grocery Corporation. You are told that a one-year Treasury Bill will have a rate of return of 5% over the next year. Also, information from an investment advising service lists the current beta for Tech.com as 1.68 and for Sam’s Grocery as 0.52. You are provided a series of questions to guide your analysis.
Estimated Rate of Return
Economy Probability Tech.com Sam's Grocery S&P 500
Recession 30% -20% 5% - 4%
Average 20% 15% 6% 11%
Expansion 35% 30% 8% 17%
Boom 15% 50% 10% 27%
Assignment:
Q1. Calculate the expected rate of return for Tech.com Incorporated, Sam’s Grocery Corporation, and the S&P 500 Index.
Q2. Calculate the standard deviations in estimated rates of return for Tech.com Incorporated, Sam’s Grocery Corporation, and the S&P 500 Index.
Q3. Which is a better measure of risk for the common stock of Tech.com Incorporated and Sam’s Grocery Corporation—the standard deviation you calculated in Question 2 or the beta?
Q4. Based on the beta provided, what is the expected rate of return for Tech.com Incorporated and Sam’s Grocery Corporation for the next year?
Q5. If you form a two-stock portfolio by investing $30,000 in Tech.com Incorporated and $70,000 in Sam’s Grocery Corporation, what is the portfolio beta and expected rate of return?
Q6. If you form a two-stock portfolio by investing $70,000 in Tech.com Incorporated and $30,000 in Sam’s Grocery Corporation, what is the portfolio beta and expected rate of return?
Q7. Which of these two-stock portfolios do you prefer? Why?