Business Finance 620 Problem Set Chapter 10 Risk, Return and the Opportunity Cost of Capital Chapter 11 Risk, Return and Capital Budgeting Questions: 1. Visit the course website (on Carmen) to download the Excel spreadsheet containing monthly adjusted closing prices for each of the following companies for the period from January 2003 through January 2007 (you will find the spreadsheet posted with this assignment): • Apache Corporation (APA) • Boston Scientific (BSX) • General Motors (GM) • Home Depot (HD) • Southwest Airlines (LUV) • Wal-Mart Stores (WMT) The same spreadsheet also contains values for the S&P 500 Index (^GSPC) for the same time period. All the price figures in the spreadsheet are beginning-of-the-month values. Using the values in the spreadsheet, calculate the monthly percent total return for each stock and the stock index for January 2003 through December 2006. 2. Calculate the average monthly percent return for each stock and the stock index. (Use the AVERAGE function on Excel) 3. a. Calculate the standard deviation of monthly returns for each stock and the stock index. (Use the STDEV function on Excel) b. Which of these 7 financial assets exhibits the greatest total risk? Explain. 4. Plot the time series of monthly returns for each of the 6 stocks (use Excel’s CHART function, with a separate chart for each stock; charts should have the same vertical scale). How do the trend lines differ? 5. a. Calculate the correlation coefficient between the monthly returns for each pair of stocks (use Excel’s CORREL function). b. How should the coefficient values from (a) be interpreted? 6. Consider a two-stock portfolio of APA and WMT with equal (50%) portfolio weights. a. Calculate the portfolio’s average monthly percent return. b. Calculate the portfolio’s standard deviation of monthly returns. c. Compare the portfolio’s standard deviation from (b) with the standard deviations for the individual stocks from 3(a). What do you notice? d. What factors might explain the outcome in (c)? 2 7. If you want to reduce the total risk of the two-stock portfolio in Question 6, which one (if any) of the other 4 stocks would you add to the portfolio? Explain. (Assume the stocks in the three-stock portfolio will have equal portfolio weights) 8. a. Using the S&P 500 Index as a proxy for “the stock market,” calculate the market risk measure for each of the 6 stocks. b. Which stock exhibits the greatest market risk? Explain. c. Which stock appears to be subject to the greatest unique risk? Explain. 9. Considering their market risk, what rate of return should investors expect from each of the 6 stocks? Use the beta values you calculated in Question 8, and assume: • the T-bill (risk-free) rate is 4.65%, and • the market risk premium (based on the S&P 500 index) is 8.85%. How should these returns be interpreted? Bill Microsoft Word - BFIN 620 Problem Set CH10-11.doc