Question

Discussion board:

Risk, Return, and the Capital Asset Pricing ModelAs a first day intern at Tri-Star Management Incorporated the CEO asks you to analyze the following in-formation pertaining to two common stock investments, Tech.com Incorporated and Sam’s Grocery Cor-poration. 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%

1. Which of these two-stock portfolios do you prefer? Why

Answer 1

Expected return from Tech.com =[-20*.3]+[15*.2]+[30*.35]+[50*.15]

                                             = 15%

Expected return from sam grocery : [5*.3]+[6*.2]+[8*.35]+[10*.15]

                                       = 7%

Expected return from s&p (market) =[-4*.3]+[11*.20]+[17*.35]+[27*.15]=11%

Required return from tech.com :Rf+[Beta(Rm-Rf)]

                            = 5+ [1.68(11*5)]

                            = 5+ [1.68*6]

                            = 5+ 10.08

                            = 15.08%

Required return from sam 5 +[.52(11-5)].

                    = 5+ [.52 *6]

                     = 5+ 3.12

                         = 8.12%

since Both stock are yielding more than there expected return ,both are acceptable.However we will prefer most "Sam grocery"as it is yielding more by 1.12% than expected [8.12-7] as against Tech.com by .08% [15.08-15]