Question

Risk and Return Example

There is a Minnesota Pharmaceuticals company that sent a product to be evaluated by the FDA. There are 5 outcomes; that it is approved, that it receives contingent approval, that it is sent back for more analysis of the data, that it is sent back to gather more data and do more analysis, or that it is rejected

The company is part of the S&P 1500. Thus S&P 1500 will move some based on these outcomes.

The riskless asset yields 1%

---------------------

Outcome          Prob.      MN Pharm   S&P 1500

Failure          30%      -12%           -1.83%

Gather Data 25%         -7%           -1.02%
Analysis      20%           0%           7.95%

Contingent    20%       18%            9.21%

Approve         5%       110%            11.42%

all the answer in ecxcel sheet

requirement 1

Expected Return to MN Pharma? Expected Return to S&P 1500 Variance of MN Pharma Variance of S&P 1500 Covariance between the two Beta CAPM solution Is MN Pharma a good investment?

requirement 2

Further

Suppose you had a portfolio of 1/3 MN Pharma, 1/3 S&P 1500, and 1/3 the riskless asset. ?What is the expected return of the portfolio? ?What is the portfolio beta? ?If you disliked risk, is this better than investing only in the market? Explain. What is the expected return and beta if it is 50% MN Pharma and 25% each S&P 500 and riskless?

requirement 3

Calculate

Suppose Iowa Pharma has a beta of 1.3 and an expected return of 4.4% Is it a good investment The portfolio return and beta if you use ¼ MN Pharma, ¼ Iowa Pharma, ¼ Market and ¼ riskless Do the same for 1/3 for each company and 1/3 for the market (no riskless)

Answer 1

Outcome	Prob.	MN Pharm	S&P 1500
Failure	30%	-12%	-1.83%
Gather Data	25%	-7%	-1.02%
Analysis	20%	0%	7.95%
Contingent	20%	18%	9.21%
Approve	5%	110%	11.42%
Expected Return of MN Pharma			3.8%		sumproduct (prob, MN Pharma)			Summation of probability multiplied by returns
Expected Return of S&P 1500			3.2%		sumproduct (prob, S&P1500)			Summation of probability multiplied by returns
Variance MN Pharma	0.25602		Used Var function in excel
Variance S&P1500	0.003760643
Riskless Yield	1%
Beta (MN Pharma)	4.73
Cost of equity	11%
Requirement 2
Expected Return of The Portfolio	2.65%	(1/3 MN pharma, 1/3 S&P 1500 , 1/3 Riskless Yield)
Portfolio Beta	2.24
If I don't like risk then this is not better as expected return from S&P 1500 is 3.2%
If Portfolio consists of --------------------------------------->			MN Pharma	50%
Portfolio Beta	2.62		S&P	25%
			Riskless	25%
Expected Return	2.9%
Requirement 3
Iowa Pharma	Beta	1.3
Expected Return		4.40%
It’s a good investment as it gives better returns that the market
		Share	Returns	Beta
Portfolio	M N pharma	25%	3.8%	4.73
	Iowa Pharma	25%	4.40%	1.3
	Riskless	25%	1%	0
	Market	25%	3.2%	1
Expected Return	3%
Portfolio Beta	1.76
		Share	Returns	Beta
	M N pharma	0.33	3.8%	4.73
	Iowa Pharma	0.33	4.4%	1.30
	Market	0.33	3.2%	1.00
Expected Return	3.8%
Portfolio Beta	2.34