Task: Southeastern Specialty, Inc. (SSI)—Financial Risk
State of the Economy Probability 1-Year T-Bill Project A Project B S&P Fund Equity in SSI
Poor 0.10 7.0% -8.0% 18.0% -15.0% 0.0%
Below Average 0.20 7.0% 2.0% 23.0 % 0.0 % 5.0%
Average 0.40 7.0% 14.0% 7.0% 15.0% 10.0%
Above Average 0.20 7.0% 25.0% -3.0% 30.0% 15.0%
Excellent 0.10 7.0% 33.0% 2.0% 45.0% 20.0%
Suppose SSI forms a two-asset portfolio by investing in both Project A and B.
a. To begin, assume that the required investment is the same for both projects-say, $5 million each.
1) What will be the portfolio’s expected rate of return, standard deviation, and coefficient of variation?
2) How do these values compare with the corresponding values for the individual projects?
3) What characteristic of the two return distributions make risk reduction possible?
b. What do you think will happen to the portfolio’s expected rate of return and standard deviation if the portfolio contained 75 percent of Project A? If it contained 75 percent of Project B?