1. Risk-Adjusted Return Measurements Assume the following information over a five-year period:
- Average risk-free rate = 6%
- Average return for Crane stock = 11%
- Average return for Load stock = 14%
- Standard deviation of Crane stock returns = 2% ? Standard deviation of Load stock returns = 4%
- Beta of Crane stock = 0.8
- Beta of Load stock = 1.1
Determine which stock has higher risk-adjusted returns according to the Sharpe index. Which stock has higher risk-adjusted returns according to the Treynor index? Show your work.
2. Measuring Expected Return Assume Mess stock has a beta of 1.2. If the risk-free rate is 7 percent and the market return is 10 percent, what is the expected return of Mess stock?
a. At the present time, the price-earnings ratio (stock price per share divided by earnings per share) of other firms in Carson's industry is relatively low but should rise in the future. Why might this information affect the time at which Carson issues its stock?
b. Assume that Carson Company believes that issuing stock is an efficient means of circumventing the potential for high interest rates. Even if long-term interest rates have increased by the time it issues stock, Carson thinks that it would be insulated by issuing stock instead of bonds. Is this view correct?
c. Carson Company recognizes the importance of a high stock price at the time it engages in an IPO (if it goes public). But why would its stock price be important to Carson Company even after the IPO?
d. If Carson Company goes public, it may be able to motivate its managers by granting them stock as part of their compensation. Explain why the stock may moti-vate them to perform well. Then explain why the use of stock as compensation may motivate them to focus on short-term goals even though they are supposed to focus on maximizing shareholder wealth over the long run. How can a firm provide stock as motivation but prevent its managers from using a short-term focus?