ASSIGNMENT QUESTIONS

1. Unicom is a regulated utility serving northern Illinois. Following table lists the
stock prices & dividends on Unicom from 1989-1998.

Year Price (in $) Dividends (in

$)
1989 36.10 3.00
1990 33.60 3.00
1991 37.80 3.00
1992 30.90 2.30
1993 26.80 1.60
1994 24.80 1.60
1995 31.60 1.60
1996 28.50 1.60
1997 24.25 1.60
1998 35.60 1.60

a) Estimate the average annual return you would have made on your
investment.

b) Estimate the standard deviation and variance in annual returns.

2. The following table summarizes the annual returns you would have made on
2 companies: Scientific Atlanta (satellite & data equipment manufacturer)
and AT&T (telecommunications giant) - from 1989-1998.

Year S.A. (in %) AT&T (in %)

1989 80.95 58.26
1990 -47.37 -33.79
1991 31.00 29.88
1992 132.44 30.35
1993 32.02 2.94
1994 25.37 -4.29
1995 -28.57 28.86
1996 0.00 -6.36
1997 11.67 48.64
1998 36.19 23.55

a) Estimate the average annual return and standard deviation in annual

returns in each company.

b) Estimate the covariance and correlation in returns between the 2

companies.
 c) Estimate the variance of portfolio composed, in equal parts, of the 2
investments.

3. You are in a world where there are only 2 assets; gold & stocks. You are
interested in investing your money in one, the other or both assets.
Consequently you collect the following data on the returns on the 2 assets
over the past 6 years.

Gold Stock Market

Average Return 8% 20%
Standard Deviation 25% 22%
Correlation -0.4

a) If you were constrained to pick just one, which one would you choose?

b) A friend argues that this is wrong. He says that you are ignoring the big
pay offs that you can get on the other asset. How would you go about
alleviating his concern?

c) How would a portfolio composed of equal proportions in gold and stocks

do in terms of mean and variance?

d) You know that GPEC (a cartel of gold producing countries) is going to vary
the amount of gold it produces in relation to stock prices in U.S. (GPEC will
produce less gold when stock markets are up and more when they are
down.) What effect will this have on your portfolio? Explain.

4. You are interested in creating portfolio of 2 stocks- Coca-Cola and Texas

Utilities. Over the past decade the investment in Coca-Cola stock would have
earned an average annual return of 25%, with a standard deviation in returns
of 36%. An investment in Texas utility stocks would have earned an average
annual return of 12%, with a standard deviation in returns of 22%. The
correlation in returns across the 2 stocks is 0.28.

a) Assuming the average return and standard deviation, estimated using

past returns, will continue to hold in the future, estimate future average
returns and standard deviation of a portfolio composed of 60% of Coca-
Cola and 40% of Texas Utility stock.

b) Now assume that Coca-Colas international diversification will reduce the

correlation to 0.20, while increasing Coca-Colas standard deviation in
 returns to 45%. Assuming all other numbers remains unchanged. Estimate
one standard deviation of the portfolio in (a).

5. Assume that you have half your money invested in Times Mirror (the media
company), and other half invested in Unilever (FMCG). The expected returns
and standard deviation on both investments are:

Times Unilever
Mirror
Expected Return 14% 18%
Standard Deviation 25% 40%

Estimate the variance of the portfolio as the function of the correlation

coefficient (start with -1 and increase the correlation to +1 in 0.2
increments).

6. You have been asked to analyze the standard deviation of a portfolio

composed of following 3 assets:

Expected Standard
Return Deviation
Sony Corporation 11% 23%
Tesoro Petroleum 9% 27%
Storage Technology 16% 50%

You have also been provided the correlation across these 3 investments:

Sony Corporation Tesoro Storage

Petroleum Technology
Sony Corporation 1.00 -0.15 0.20
Tesoro Petroleum -0.15 1.00 -0.25
Storage 0.20 -0.25 1.00
Technology

Estimate the variance of a portfolio, equally weighted across all 3 assets.

7. United Airlines has a beta of 1.5. The standard deviation in the market
portfolio is 22%., and United Airlines has a standard deviation of 66%.
 a) Estimate the correlation between United Airlines and the market portfolio.

b) What proportion of United Airlines risk is market risk?

8. You are using the arbitrage pricing model to estimate the expected return on
Bethlehem Steel, and derived the following estimates for factor betas and
risk premium;

Factor Beta Risk Premium (in

%)
1 1.2 2.5
2 0.6 1.5
3 1.5 1.0
4 2.2 0.8
5 0.5 1.2
a) Which risk factor is Bethlehem Steel most exposed to? Is there any way in
the arbitrage pricing model, to identify the risk factor?

b) If the risk free rate is 5%, estimate the expected return on Bethlehem
Steel.

c) Now assume that beta in the CAPM for Bethlehem Steel is 1.1, and that
the risk premium for market portfolio is 5%. Estimate the Expected return
using CAPM.

d) Why are the expected returns different using the 2 models?

9. You are using the multifactor model to estimate the expected return on
Emmerson Electric, and have derived the following estimates for the factor
betas and risk premiums:

Macroeconomic Measure Beta Risk premium

Factor (R factor-Rf)
Level of interest T bond Rate 0.5 1.8%
rate
Term Structure T bond Rate-T bill 1.4 0.6%
rate
Inflation Rate Consumer Price 1.2 1.5%
Index
Economic Growth Gross national 1.8 4.2%
product growth
rate

With riskless rate of 6%, estimate the expected return on Emmerson Electric.
10.Genting Belhard is a Malaysian conglomerate with holdings in plantations and
tourists resorts. The beta estimated for the firm relative to the Malaysian
stock exchange is 1.15, and the long term Government borrowing rate in
Malaysia is 11.5% (the Malaysian Risk premium is 12%)

a) Estimate the expected return on the stock.

11.You have just done a regression on monthly stock returns of Heavy Tech Inc.
(manufacturer of heavy machinery) on monthly market returns over the past
5 years and have come up with following regression:

R HeavyTech = 0.5% + 1.2 Rm

Variance of the stock is 50%, and market variance is 20%. Current T-Bill rate
is 3% (it was 5% one year ago). The stock is currently selling for $50, down
$4 over the past year, with dividend paid of $2 during the past year and
expects to pay a dividend of $ 2.50 over the next year. The NYSE composite
has gone down 8% over the past year, with a dividend yield of 3%. Heavy
Tech Inc. has a Tax rate of 40%.

a) What is the expected return of Heavy Tech over the next year?

b) What would you expect Heavy Techs price to be one year from today?

c) Calculate total risk of Heavy Tech.

12.You have just run a regression of monthly returns of American Airlines (AMR
Corporation) against S&P 500 over the past 5 years. You have misplaced
some of the output and are trying to derive it from what you have.

a) You know the R-squared of the regression is 0.36, and that your stock has
a variance of 67%. The market variance is 12%. What is the Beta of AMR.

b) You are comparing AMR to another firm, which has an R-squared of 0.48.
Will the 2 firms have same beta? If not, why?