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Chapter 8
Risk and Rates of Return
Learning Objectives
After reading this chapter, students should be able to:
◆ Explain the difference between stand-alone risk and risk in a portfolio context.
◆ Describe how risk aversion affects a stock’s required rate of return.
◆ Discuss the difference between diversifiable risk and market risk, and explain how each type of risk
affects well-diversified investors.
◆ Describe what the CAPM is and illustrate how it can be used to estimate a stock’s required rate of
return.
◆ Discuss how changes in the general stock and bond markets could lead to changes in the required
rate of return on a firm’s stock.
◆ Discuss how changes in a firm’s operations might lead to changes in the required rate of return on
the firm’s stock.
Chapter 8: Risk and Rates of Return Learning Objectives 183

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Lecture Suggestions
Risk analysis is an important topic, but it is difficult to teach at the introductory level. We just try to give
students an intuitive overview of how risk can be defined and measured, and leave a technical treatment
to advanced courses. Our primary goals are to be sure students understand (1) that investment risk is
the uncertainty about returns on an asset, (2) the concept of portfolio risk, and (3) the effects of risk on
required rates of return.
What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case
solution for Chapter 8, which appears at the end of this chapter’s solutions. For other suggestions about
the lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our
classes.
DAYS ON CHAPTER: 3 OF 56 DAYS (50-minute periods)
184 Lecture Suggestions Chapter 8: Risk and Rates of Return

Answers to End-of-Chapter Questions
8-1 a. No, it is not riskless. The portfolio would be free of default risk and liquidity risk, but inflation
could erode the portfolio’s purchasing power. If the actual inflation rate is greater than that
expected, interest rates in general will rise to incorporate a larger inflation premium (IP)
and—as we saw in Chapter 6—the value of the portfolio would decline.
b. No, you would be subject to reinvestment risk. You might expect to “roll over” the Treasury
bills at a constant (or even increasing) rate of interest, but if interest rates fall, your
investment income will decrease.
c. A U.S. government-backed bond that provided interest with constant purchasing power (that
is, an indexed bond) would be close to riskless. The U.S. Treasury currently issues indexed
bonds.
8-2 a. The probability distribution for complete certainty is a vertical line.
b. The probability distribution for total uncertainty is the X-axis from - to +.
8-3 a. The expected return on a life insurance policy is calculated just as for a common stock. Each
outcome is multiplied by its probability of occurrence, and then these products are summed.
For example, suppose a 1-year term policy pays $10,000 at death, and the probability of the
policyholder’s death in that year is 2%. Then, there is a 98% probability of zero return and a
2% probability of $10,000:
Expected return = 0.98($0) + 0.02($10,000) = $200.
This expected return could be compared to the premium paid. Generally, the premium
will be larger because of sales and administrative costs, and insurance company profits,
indicating a negative expected rate of return on the investment in the policy.
b. There is a perfect negative correlation between the returns on the life insurance policy and
the returns on the policyholder’s human capital. In fact, these events (death and future
lifetime earnings capacity) are mutually exclusive.
c. People are generally risk averse. Therefore, they are willing to pay a premium to decrease
the uncertainty of their future cash flows. A life insurance policy guarantees an income (the
face value of the policy) to the policyholder’s beneficiaries when the policyholder’s future
earnings capacity drops to zero.
8-4 Yes, if the portfolio’s beta is equal to zero. In practice, however, it may be impossible to find
individual stocks that have a nonpositive beta. In this case it would also be impossible to have a
stock portfolio with a zero beta. Even if such a portfolio could be constructed, investors would
probably be better off just purchasing Treasury bills, or other zero beta investments.
8-5 Security A is less risky if held in a diversified portfolio because of its negative correlation with
other stocks. In a single-asset portfolio, Security A would be more risky because A > B and
CVA > CVB.
8-6 No. For a stock to have a negative beta, its returns would have to logically be expected to go up
in the future when other stocks’ returns were falling. Just because in one year the stock’s return
Chapter 8: Risk and Rates of Return Answers and Solutions 185

increases when the market declined doesn’t mean the stock has a negative beta. A stock in a
given year may move counter to the overall market, even though the stock’s beta is positive.
8-7 The risk premium on a high-beta stock would increase more than that on a low-beta stock.
RPj = Risk Premium for Stock j = (rM – rRF)bj.
If risk aversion increases, the slope of the SML will increase, and so will the market risk premium
(rM – rRF). The product (rM – rRF)bj is the risk premium of the jth stock. If bj is low (say, 0.5),
then the product will be small; RPj will increase by only half the increase in RPM. However, if bj is
large (say, 2.0), then its risk premium will rise by twice the increase in RP M.
8-8 According to the Security Market Line (SML) equation, an increase in beta will increase a
company’s expected return by an amount equal to the market risk premium times the change in
beta. For example, assume that the risk-free rate is 6%, and the market risk premium is 5%. If
the company’s beta doubles from 0.8 to 1.6 its expected return increases from 10% to 14%.
Therefore, in general, a company’s expected return will not double when its beta doubles.
8-9 a. A decrease in risk aversion will decrease the return an investor will require on stocks. Thus,
prices on stocks will increase because the cost of equity will decline.
b. With a decline in risk aversion, the risk premium will decline as compared to the historical
difference between returns on stocks and bonds.
c. The implication of using the SML equation with historical risk premiums (which would be
higher than the “current” risk premium) is that the CAPM estimated required return would
actually be higher than what would be reflected if the more current risk premium were used.
186 Answers and Solutions Chapter 8: Risk and Rates of Return

Solutions to End-of-Chapter Problems
8-1 r̂ = (0.1)(-50%) + (0.2)(-5%) + (0.4)(16%) + (0.2)(25%) + (0.1)(60%)

= 11.40%.
2 = (-50% – 11.40%)2(0.1) + (-5% – 11.40%)2(0.2) + (16% – 11.40%)2(0.4)

+ (25% – 11.40%)2(0.2) + (60% – 11.40%)2(0.1)
 = 712.44;  = 26.69%.
2
26.69%
CV = = 2.34.
11.40%
8-2 Investment Beta

$35,000 0.8
40,000 1.4
Total $75,000
bp = ($35,000/$75,000)(0.8) + ($40,000/$75,000)(1.4) = 1.12.
8-3 rRF = 6%; rM = 13%; b = 0.7; r = ?
r = rRF + (rM – rRF)b

= 6% + (13% – 6%)0.7
= 10.9%.
8-4 rRF = 5%; RPM = 6%; rM = ?
rM = 5% + (6%)1 = 11%.
r when b = 1.2 = ?
r = 5% + 6%(1.2) = 12.2%.
8-5 a. r = 11%; rRF = 7%; RPM = 4%.

11% = 7% + 4%b
4% = 4%b
b = 1.

b. rRF = 7%; RPM = 6%; b = 1.

= 7% + (6%)1
= 13%.
N
8-6 a. r̂ =  Pr .
i =1
i i
r̂Y = 0.1(-35%) + 0.2(0%) + 0.4(20%) + 0.2(25%) + 0.1(45%)

= 14% versus 12% for X.
N
b.  =  (r − r̂) P
i=1
i
2
i .
σ 2X = (-10% – 12%)2(0.1) + (2% – 12%)2(0.2) + (12% – 12%)2(0.4)

+ (20% – 12%)2(0.2) + (38% – 12%)2(0.1) = 148.8.
X = 12.20% versus 20.35% for Y.
CVX = X/ r̂ X = 12.20%/12% = 1.02, while
CVY = 20.35%/14% = 1.45.
If Stock Y is less highly correlated with the market than X, then it might have a lower beta than
Stock X, and hence be less risky in a portfolio sense.
$400,000 $600,000 $1,000,000 $2,000,000

8-7 Portfolio beta = (1.50) + (-0.50) + (1.25) + (0.75)
$4,000,000 $4,000,000 $4,000,000 $4,000,000
bp = (0.1)(1.5) + (0.15)(-0.50) + (0.25)(1.25) + (0.5)(0.75)
= 0.15 – 0.075 + 0.3125 + 0.375 = 0.7625.
rp = rRF + (rM – rRF)(bp) = 6% + (14% – 6%)(0.7625) = 12.1%.
Alternative solution: First, calculate the return for each stock using the CAPM equation
[rRF + (rM – rRF)b], and then calculate the weighted average of these returns.
rRF = 6% and (rM – rRF) = 8%.
Stock Investment Beta r = rRF + (rM – rRF)b Weight

A $ 400,000 1.50 18% 0.10
B 600,000 (0.50) 2 0.15
C 1,000,000 1.25 16 0.25
D 2,000,000 0.75 12 0.50
Total $4,000,000 1.00
rp = 18%(0.10) + 2%(0.15) + 16%(0.25) + 12%(0.50) = 12.1%.

8-8 In equilibrium:
rJ = r̂J = 12.5%.
rJ = rRF + (rM – rRF)b

12.5% = 4.5% + (10.5% – 4.5%)b
b = 1.33.
8-9 We know that bR = 1.50, bS = 0.75, rM = 13%, rRF = 7%.
ri = rRF + (rM – rRF)bi = 7% + (13% – 7%)bi.
rR = 7% + 6%(1.50) = 16.0%
rS = 7% + 6%(0.75) = 11.5
4.5%
8-10 An index fund will have a beta of 1.0. If rM is 12.0% (given in the problem) and the risk-free rate is
5%, you can calculate the market risk premium (RPM) calculated as rM – rRF as follows:
r = rRF + (RPM)b
12.0% = 5% + (RPM)1.0
7.0% = RPM.
Now, you can use the RPM, the rRF, and the two stocks’ betas to calculate their required returns.
Bradford:
rB = rRF + (RPM)b
= 5% + (7.0%)1.45
= 5% + 10.15%
= 15.15%.
Farley:
rF = rRF + (RPM)b
= 5% + (7.0%)0.85
= 5% + 5.95%
= 10.95%.
The difference in their required returns is:

15.15% – 10.95% = 4.2%.
8-11 rRF = r* + IP = 2.5% + 3.5% = 6%.
r = 6% + (6.5%)1.7 = 17.05%.
8-12 a. ri = rRF + (rM – rRF)bi = 9% + (14% – 9%)1.3 = 15.5%.

b. 1. rRF increases to 10%:
rM increases by 1 percentage point, from 14% to 15%.
ri = rRF + (rM – rRF)bi = 10% + (15% – 10%)1.3 = 16.5%.
2. rRF decreases to 8%:

rM decreases by 1%, from 14% to 13%.
ri = rRF + (rM – rRF)bi = 8% + (13% – 8%)1.3 = 14.5%.
c. 1. rM increases to 16%:
ri = rRF + (rM – rRF)bi = 9% + (16% – 9%)1.3 = 18.1%.
2. rM decreases to 13%:
ri = rRF + (rM – rRF)bi = 9% + (13% – 9%)1.3 = 14.2%.
8-13 a. Using Stock X (or any stock):

9% = rRF + (rM – rRF)bX
9% = 5.5% + (rM – rRF)0.8
(rM – rRF) = 4.375%.
b. bQ = 1/3(0.8) + 1/3(1.2) + 1/3(1.6)

bQ = 0.2667 + 0.4000 + 0.5333
bQ = 1.2.
c. rQ = 5.5% + 4.375%(1.2)
rQ = 10.75%.
d. Since the returns on the 3 stocks included in Portfolio Q are not perfectly positively correlated,
one would expect the standard deviation of the portfolio to be less than 15%.
$142,500 $7,500
8-14 Old portfolio beta = (b) + (1.00)
$150,000 $150,000
1.12 = 0.95b + 0.05
1.07 = 0.95b
1.1263 = b.
New portfolio beta = 0.95(1.1263) + 0.05(1.75) = 1.1575  1.16.
Alternative solutions:
1. Old portfolio beta = 1.12 = (0.05)b1 + (0.05)b2 + ... + (0.05)b20
1.12 = ( b i ) (0.05)
b i = 1.12/0.05 = 22.4.
New portfolio beta = (22.4 – 1.0 + 1.75)(0.05) = 1.1575  1.16.

2. b i excluding the stock with the beta equal to 1.0 is 22.4 – 1.0 = 21.4, so the beta of the
portfolio excluding this stock is b = 21.4/19 = 1.1263. The beta of the new portfolio is:
1.1263(0.95) + 1.75(0.05) = 1.1575  1.16.
8-15 bHRI = 1.8; bLRI = 0.6. No changes occur.
rRF = 6%. Decreases by 1.5% to 4.5%.
rM = 13%. Falls to 10.5%.
Now SML: ri = rRF + (rM – rRF)bi.
rHRI = 4.5% + (10.5% – 4.5%)1.8 = 4.5% + 6%(1.8) = 15.3%

rLRI = 4.5% + (10.5% – 4.5%)0.6 = 4.5% + 6%(0.6) = 8.1%
Difference 7.2%
8-16 Step 1: Determine the market risk premium from the CAPM:
0.12 = 0.0525 + (rM – rRF)1.25
(rM – rRF) = 0.054.
Step 2: Calculate the beta of the new portfolio:

($500,000/$5,500,000)(0.75) + ($5,000,000/$5,500,000)(1.25) = 1.2045.
Step 3: Calculate the required return on the new portfolio:

5.25% + (5.4%)(1.2045) = 11.75%.
8-17 After additional investments are made, for the entire fund to have an expected return of 13%,
the portfolio must have a beta of 1.5455 as shown below:
13% = 4.5% + (5.5%)b
b = 1.5455.
Since the fund’s beta is a weighted average of the betas of all the individual investments, we can
calculate the required beta on the additional investment as follows:
($20,000,000)(1.5) $5,000,000X
1.5455 = +
$25,000,000 $25,000,000
1.5455 = 1.2 + 0.2X
0.3455 = 0.2X
X = 1.7275.
8-18 a. ($1 million)(0.5) + ($0)(0.5) = $0.5 million.
b. You would probably take the sure $0.5 million.
c. Risk averter.

d. 1. ($1.15 million)(0.5) + ($0)(0.5) = $575,000, or an expected profit of $75,000.
2. $75,000/$500,000 = 15%.
3. This depends on the individual’s degree of risk aversion.
4. Again, this depends on the individual.
5. The situation would be unchanged if the stocks’ returns were perfectly positively
correlated. Otherwise, the stock portfolio would have the same expected return as the
single stock (15%) but a lower standard deviation. If the correlation coefficient between
each pair of stocks was a negative one, the portfolio would be virtually riskless. Since 
for stocks is generally in the range of +0.35, investing in a portfolio of stocks would
definitely be an improvement over investing in the single stock.
8-19 r̂X = 10%; bX = 0.9; X = 35%.
r̂Y = 12.5%; bY = 1.2; Y = 25%.
rRF = 6%; RPM = 5%.
a. CVX = 35%/10% = 3.5. CVY = 25%/12.5% = 2.0.
b. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the
higher beta is more risky. Stock Y has the higher beta so it is more risky than Stock X.
c. rX = 6% + 5%(0.9)
= 10.5%.
rY = 6% + 5%(1.2)
= 12%.
d. rX = 10.5%; r̂X = 10%.

rY = 12%; r̂ Y = 12.5%.
Stock Y would be most attractive to a diversified investor since its expected return of 12.5% is
greater than its required return of 12%.
e. bp = ($7,500/$10,000)0.9 + ($2,500/$10,000)1.2
= 0.6750 + 0.30
= 0.9750.
rp = 6% + 5%(0.975)
= 10.875%.
f. If RPM increases from 5% to 6%, the stock with the highest beta will have the largest increase
in its required return. Therefore, Stock Y will have the greatest increase.

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Check:
rX = 6% + 6%(0.9)
= 11.4%. Increase 10.5% to 11.4%.
rY = 6% + 6%(1.2)
= 13.2%. Increase 12% to 13.2%.
8-20 The answers to a, b, c, and d are given below:

rA rB Portfolio
2010 (18.00%) (14.50%) (16.25%)
2011 33.00 21.80 27.40
2012 15.00 30.50 22.75
2013 (0.50) (7.60) (4.05)
2014 27.00 26.30 26.65
Mean 11.30 11.30 11.30
Std. Dev. 20.79 20.78 20.13
Coef. Var. 1.84 1.84 1.78
e. A risk-averse investor would choose the portfolio over either Stock A or Stock B alone, since the
portfolio offers the same expected return but with less risk. This result occurs because returns
on A and B are not perfectly positively correlated (rAB = 0.88).
8-21 a. r̂M = 0.1(-28%) + 0.2(0%) + 0.4(12%) + 0.2(30%) + 0.1(50%) = 13%.
rRF = 6%. (given)
Therefore, the SML equation is:

ri = rRF + (rM – rRF)bi = 6% + (13% – 6%)bi = 6% + (7%)bi.
b. First, determine the fund’s beta, bF. The weights are the percentage of funds invested in each
stock:
A = $160/$500 = 0.32.
B = $120/$500 = 0.24.
C = $80/$500 = 0.16.
D = $80/$500 = 0.16.
E = $60/$500 = 0.12.
bF = 0.32(0.5) + 0.24(1.2) + 0.16(1.8) + 0.16(1.0) + 0.12(1.6)

= 0.16 + 0.288 + 0.288 + 0.16 + 0.192 = 1.088.
Next, use bF = 1.088 in the SML determined in Part a:

r̂F = 6% + (13% – 6%)1.088 = 6% + 7.616% = 13.616%.
c. rN = Required rate of return on new stock = 6% + (7%)1.5 = 16.5%.
An expected return of 15% on the new stock is below the 16.5% required rate of return on an
investment with a risk of b = 1.5. Since rN = 16.5% > r̂N = 15%, the new stock should not be
purchased. The expected rate of return that would make the fund indifferent to purchasing the
stock is 16.5%.

Comprehensive/Spreadsheet Problem
Note to Instructors:
The solution to this problem is not provided to students at the back of their text. Instructors
can access the Excel file on the textbook’s website.
8-22 a. Bartman Reynolds Index

2014 24.7% -1.1% 32.8%
2013 -4.2% 13.2% 1.2%
2012 62.8% -10.0% 34.9%
2011 2.9% -0.4% 14.8%
2010 61.0% 11.7% 19.0%
Avg Returns 29.5% 2.7% 20.6%
Bartman Reynolds Index

b. Standard deviation of return 31.5% 9.7% 13.8%
On a stand-alone basis, it would appear that Bartman is the most risky, Reynolds the least
risky.
c. Divide the standard deviation by the average return:
Bartman Reynolds Index

Coefficient of Variation 1.07 3.63 0.67
Reynolds now looks most risky, because its risk per unit of return (CV) is the highest.
d. Year Index Bartman Reynolds

2014 32.8% 24.7% -1.1%
2013 1.2% -4.2% 13.2%
2012 34.9% 62.8% -10.0%
2011 14.8% 2.9% -0.4%
2010 19.0% 61.0% 11.7%
Stocks' Stock Returns Vs. Index

Returns
70%
60%
50%
40%
30% Bartman
20%
10% Reynolds
0%
-10%0.0% 10.0% 20.0% 30.0% 40.0%
-20%
Index Returns
It is clear that Bartman moves with the market and Reynolds moves counter to the market.
So, Bartman has a positive beta and Reynolds a negative one.
194 Comprehensive/Spreadsheet Problem Chapter 8: Risk and Rates of Return

e. Bartman’s calculations:
SUMMARY OUTPUT
Bartman's beta = 1.539
Regression Statistics
Multiple R 0.67528
R Square 0.45600
Adjusted R Square 0.27467
Standard Error 0.26819
Observations 5
ANOVA
df SS MS F Significance F
Regression 1 0.18087 0.18087 2.51472 0.21097
Residual 3 0.21578 0.07193
Total 4 0.3966501
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -0.02177 0.23276 -0.09354 0.93137 -0.76252 0.71898 -0.76252 0.71898
X Variable 1 1.53889 0.97043 1.58579 0.21097 -1.54945 4.62724 -1.54945 4.62724
RESIDUAL OUTPUT
Observation Predicted Y Residuals

1 0.48239 -0.23493
2 -0.00303 -0.03879
3 0.51542 0.11249
4 0.20670 -0.17768
5 0.27133 0.33891
Reynolds’ calculations:
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.79735
R Square 0.63576 Reynolds' beta = -0.560
Adjusted R Square 0.51435
Standard Error 0.06769
Observations 5
ANOVA
df SS MS F Significance F
Regression 1 0.02399 0.02399 5.23641 0.10612
Residual 3 0.01374 0.00458
Total 4 0.03774
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.14196 0.05874 2.41659 0.09446 -0.04499 0.32892 -0.04499 0.32892
X Variable 1 -0.56046 0.24492 -2.28832 0.10612 -1.33991 0.21899 -1.33991 0.21899
RESIDUAL OUTPUT
Observation Predicted Y Residuals

1 -0.04165 0.03113
2 0.13514 -0.00283
3 -0.05368 -0.04676
4 0.05875 -0.06292
5 0.03522 0.08138
Note that these betas are consistent with the scatter diagrams we constructed earlier.
Reynolds' beta suggests that it is less risky than average in a CAPM sense, whereas Bartman is
more risky than average.
Chapter 8: Risk and Rates of Return Comprehensive/Spreadsheet Problem 195

f. Market return = 11.000%
Risk-free rate = 6.040%
Required return = Risk-free rate + Market risk premium × Beta
Bartman:
Required return = 6.040% + 4.960% × 1.539
Required return = 13.673%
Reynolds:
Required return = 6.040% + 4.960% × -0.560
Required return = 3.260%
This suggests that Reynolds' stock is like an insurance policy that has a low expected return,
but it will pay off in the event of a market decline. Actually, it is hard to find negative-beta
stocks, so we would not be inclined to believe the Reynolds' data.
g. The beta of a portfolio is simply a weighted average of the betas of the stocks in the portfolio,
so this portfolio's beta would be:
Portfolio beta = 0.489
Required return on portfolio = Risk-free rate + Market risk premium  Beta

Required return = 6.040% + 4.960% × 0.489
Portfolio required return = 8.467%
h. Portfolio
Beta Weight
Bartman 1.539 25%
Stock A 0.769 15%
Stock B 0.985 40%
Stock C 1.423 20%
100%
Portfolio Beta = 1.179
Required return on portfolio = Risk-free rate + Market risk premium  Beta

Required return on portfolio = 6.04% + 4.96% × 1.179
Required return on portfolio = 11.886%
196 Comprehensive/Spreadsheet Problem Chapter 8: Risk and Rates of Return

Integrated Case
8-23
Merrill Finch Inc.
Risk and Return
Assume that you recently graduated with a major in finance. You just landed a
job as a financial planner with Merrill Finch Inc., a large financial services
corporation. Your first assignment is to invest $100,000 for a client. Because the
funds are to be invested in a business at the end of 1 year, you have been
instructed to plan for a 1-year holding period. Further, your boss has restricted
you to the investment alternatives in the following table, shown with their
probabilities and associated outcomes. (For now, disregard the items at the
bottom of the data; you will fill in the blanks later.)
Returns on Alternative Investments

Estimated Rate of Return
State of the High Collec- U.S. Market 2-Stock
Economy Prob. T-Bills Tech tions Rubber Portfolio Portfolio
Recession 0.1 5.5% -27.0% 27.0% 6.0%a -17.0% 0.0%
Below Avg. 0.2 5.5 -7.0 13.0 -14.0 -3.0
Average 0.4 5.5 15.0 0.0 3.0 10.0 7.5
Above Avg. 0.2 5.5 30.0 -11.0 41.0 25.0
Boom 0.1 5.5 45.0 -21.0 26.0 38.0 12.0
r-hat ( r̂ ) 1.0% 9.8% 10.5%

Std. dev. () 0.0 13.2 18.8 15.2 3.4
Coeff. of Var. (CV) 13.2 1.9 1.4 0.5
beta (b) -0.87 0.88
Note:
a
The estimated returns of U.S. Rubber do not always move in the same direction as the
overall economy. For example, when the economy is below average, consumers purchase
fewer tires than they would if the economy was stronger. However, if the economy is in a flat-
out recession, a large number of consumers who were planning to purchase a new car may
choose to wait and instead purchase new tires for the car they currently own. Under these
circumstances, we would expect U.S. Rubber’s stock price to be higher if there is a recession
than if the economy was just below average.
Chapter 8: Risk and Rates of Return Integrated Case 197

Exploring the Variety of Random
Documents with Different Content
PLATE CCXLIV.
HEMEROCALLIS GRAMINEA.
Grass-leaved Day-Lily.
CLASS VI. ORDER I.

HEXANDRIA MONOGYNIA. Six Chives. One Pointal.
ESSENTIAL GENERIC CHARACTER.
Corolla campanulata; tubo cylindrico.

Stamina declinata.
Blossom bell-shaped; tube cylindrical.
Chives declining.
See Hemerocallis cærulea, Pl. VI. Vol. I.
SPECIFIC CHARACTER.
Hemerocallis foliis linearibus, carinatis, gramineis; petalis tribus

interioribus majoribus undulatis, exterioribus minoribus, extus bruneis.
Hemerocallis with linear leaves, keeled and grassy; the three inner petals
larger, waved, the outer smaller, brown on the outside.
REFERENCE TO THE PLATE.
1. An outer leaf of the Blossom, shewn from the outside.

2. The Chives and Pointal.
3. The Pointal and Seed-bud, cleared of the chives.
We have little doubt but that this is the species of Day-Lily known to
botanists, since the days of Parkinson and Gerarde, under the character of a
small leaved variety of the Yellow Day-Lily, although it has been many
years lost to the country. It is one amongst the many plants introduced by the
late Dr. Sibthorpe, to the Oxford botanic garden. As a native of the northern
parts of Europe, it is as hardy as either the H. flava or H. fulva, to both
which species it bears strong affinity; although, we conceive, sufficiently
distinct from either, to constitute a species; which however we should not
have done, but that the plant is now known in our gardens, under our specific
title. The flowers of this plant last, in general, two or three days before they
decay, are very sweet scented, and as large as those of the H. fulva. It is
increased as easily as any of the genus, by parting the roots, and thrives in
almost any soil.
PLATE CCXLV.
IXIA PUSILLA.
Dwarf blue Ixia.
CLASS III. ORDER I.

TRIANDRIA MONOGYNIA. Three Chives. One Pointal.
Corolla 6 partita, patens, æqualis. Stigmata tria, erectiusculo-patula.

Blossom 6-divided, spreading, equal. Summits three, between upright
and spreading.
See Ixia reflexa, Pl. XIV. Vol. I.
SPECIFIC CHARACTER.
Ixia foliis sublinearibus, costatis, crassis; scapo bifloro, longitudine,

foliorum; floribus distantibus, cæruleis.
Ixia with nearly linear leaves, ribbed, thick; flower-stem two-flowered,
the length of the leaves; flowers grow distant, and are blue.
1. The two valves of the sheath.

2. A Flower cut open, with the Chives in their place.
3. The Pointal, one of the summits detached and magnified.
This pretty little Ixia is quite new to our gardens, never having, as far as we
can learn, been seen to flower before this year. It is the most delicate in
shape and character of any we have as yet examined; and as we could not
trace it as described in any author, we have given it the trivial name it here
bears. The figure exhibits a large specimen of the whole plant, which is too
weak to support itself, although the leaves are thick and stiff. Our drawing
was made in the month of April, from a plant in the Clapham collection,
where only it is to be found; the roots having been sent from the Cape of
Good Hope in the autumn of the preceding year. It appears to flourish with
the treatment Mr. Allen has given it, a dry situation, planted in very sandy
peat. From the construction of the root, which has a hard smooth skin, we
should be led to think its increase will not be very abundant.
PLATE CCXLVI.
GERANIUM INCRASSATUM.
Fleshy-leaved Geranium.
CLASS XVI. ORDER IV.

MONADELPHIA DECANDRIA. Threads united. Ten Chives.
Monogyna. Stigmata quinque.

Fructus rostratus, penta-coccus.
One Pointal. Five Summits.
Fruit furnished with long awns, five dry berries.
See Geranium grandiflorum. Pl. XII. Vol. I.
SPECIFIC CHARACTER.
Geranium foliis carnosis, inequaliter pinnatis seu lobatis, laciniis

tridentatis, obtusis; corollis saturate rubris, striatis; floribus pentandris;
radice tuberosa.
Geranium with fleshy leaves, unequally winged or lobed, segments three-
toothed, blunt; blossoms of a deep red, and streaked; flowers with five fertile
tips; root tuberous.
1. The Empalement cut open, to shew its tubular structure.

2. The Chives spread open.
3. The Pointal, natural size, with the summits detached, magnified.
Our figure, which exhibits a small plant, of this superb species of
tuberous Geranium, was taken in the month of June, this year, 1802, at
Messrs. Colville’s nursery, King’s Road, Chelsea, and where it is still in high
perfection, this present month of July. We have every reason to believe, from
all the authorities we are masters of, that this plant has not, till now, flowered
in Europe. It forms a very large tuberous root, by the dividing of which it is
to be propagated; as we suspect the seeds will not ripen on this species more
than most of its congeners. It has the same manner with the rest of the
tuberous species, losing its leaves in winter, when they are subject to rot, if
much watered. Appears to flourish in sandy peat, with a small portion of
rotten dung.
PLATE CCXLVII.
GERANIUM CILIATUM.
Fringed-leaved Geranium.
CLASS XVI. ORDER IV.

MONADELPHIA DECANDRIA. Threads united. Ten Chives.
Monogyna. Stigmata quinque. Fructus rostratus, pentacoccus.

One Pointal. Five summits. Fruit furnished with long awns, five dry
berries.
See Geranium grandiflorum, Pl. XII. Vol. I.
SPECIFIC CHARACTER.
Geranium foliis intigerrimis, concavis, lanceotis, marginibus ciliatis;

floribus pentandris; radice tuberosa.
Geranium with quite entire leaves, concave, lance-shaped, and fringed at
the edge; flowers with five fertile chives; root tuberous.
1. The Empalement.
2. The Chives spread open, magnified.
3. The Pointal, magnified.
The singular shape and number of the leaves of this plant, which are but
two, large, concave, thickish, between lance and egg-shaped, and fringed at
the edge, constitute the most essential specific difference it possesses; the
flowers, and other parts, much resemble many of its fellows. It is from the
Cape of Good Hope, and introduced to us by Messrs. Colvills, nurserymen,
of the King’s Road, Chelsea; who received it, from thence, at the same time
with the Geranium incrassatum, of our last. For the treatment, and increase,
we must refer to any other of the tuberous kind of Geranium.
PLATE CCXLVIII.
PROTEA UMBELLATA.
Umbellated Protea.
CLASS IV. ORDER I.

TETRANDRIA MONOGYNIA. Four Chives. One Pointal.
Corolla 4-fida seu 4-petala. Antheræ lineares, insertæ petalis infra

apicem. Calyx proprius nullus. Semina solitaria.
Blossom 4-cleft or 4 petals. Tips linear, inserted into the petals below the
point. Cup proper none. Seeds solitary.
See Protea formosa, Pl. XVII. Vol. I.
SPECIFIC CHARACTER.
Protea foliis lineari-spathulatis, glabris; capitulis terminalibus; bracteis

multifidis; floribus luteis.
Protea with linearly-spathulate leaves, smooth; heads of flowers terminate
the branches; floral leaves many cleft; flowers yellow.
1. One of the floral leaves or scales of the general empalement,

magnified.
2. A flower, magnified.
3. One of the heads of flowers, divested of the scales, or floral
leaves.
4. The Pointal and seed bud, of one of the florets, magnified.
The Protea umbellata has been cultivated in England since the year 1777, at
which time it was first raised from seeds; received from the Cape of Good
Hope by Messrs. Lee and Kennedy, Hammersmith, at whose nursery our
figure was taken in the month of August 1800. It is a very hardy plant, and
not at all subject to the very common fate of its congeners; that is, to damp
in the leaves, or rot at the root in winter; is propagated by cuttings, to be
made in the month of April or May, and treated as directed for the other
Proteas. The plant seldom grows higher than three feet, and does not make
many branches; but is of a lively green colour, both leaves and stem. We
have, as usual, adopted the name this plant is generally known by, it having
been so named by the younger Linnæus in his Suppl. Plant. 118, and by
Thunberg in his Dissertatio de Protea, p. 34, and his Prodromus 26. But why
or how a small, close head of flowers may be denominated an umbel we
must confess our ignorance in this application of terms.
PLATE CCXLIX.
PITCAIRNIA SULPHUREA.
Sulphur-coloured Pitcairnia.
CLASS VI. ORDER I.

HEXANDRIA MONOGYNIA. Six Chives. One Pointal.
GENERIC CHARACTER.
Calyx. Perianthium monophyllum, semi-superum, tubulosum, basi

ventricosum, trifidum, persistens; laciniis lanceolatis, erectis.
Corolla tubulata, calyce duplo longior, marcessens, trifida, demum
tripetala; laciniæ lineari-oblongæ, suberectæ.
Stamina. Filamenta sex, filiformia. Antheræ oblongæ, erectæ.
Pistillum. Germen superum, ovato-triquetrum. Stylus filiformis
longitudine staminum. Stigmata tria, contorta.
Pericarpium. Capsula ovatis, obtuse triquetra, trilocularis; loculis sub-
cylindraceis, sub-distinctis.
Semina numerosa, alata, linearia.
Empalement. Cup one leafed, half superior, tubular, swelling at the base,
three-cleft; segments lance-shaped, erect.
Blossom. tubular, twice the length of the cup, withering, three-cleft, at
last three petalled; segments linearly-oblong, nearly upright.
Chives. Threads six, thread-shaped. Tips oblong, erect.
Pointal. Seed-bud above, three-sided-egg-shaped. Shaft thread-shaped
the length of the chives. Summits three, twisted.
Seed-vessel. Capsule egg-shaped, bluntly three cornered, three valved;
cells nearly cylindrical, not very distinct.
Seeds numerous, winged, linear.
SPECIFIC CHARACTER.
Pitcairnia foliis non spinosis, flaccidis, longissimis; corollis sulphureis.

Pitcairnia with leaves without spines, weak and very long; blossoms
sulphur coloured.
1. The Empalement and floral leaf.

2. One of the Petals shewn from the inside to expose the Honey-
cup at its base.
3. The Chives and Pointal.
4. The Pointal and Seed-bud, the three summits detached and
untwisted.
5. The Seed-vessel cut across.
This species of Pitcairnia was sent in the year 1799, from the island of St.
Vincent, by Mr. Anderson, to T. Evans, Esq. Stepney; at whole gardens the
plant has flowered, for the first time, in England this year, in the month of
April, and at which time our figure was taken. The Pitcairnias are all natives
of West India Islands, and stand, as the link, between the Bromelia or Pine-
apple plant, and the Tillandsia; to either of which Genera the first sight of the
leaves, only, would consign them. Five species are now in Britain, and we do
not doubt, but the species are as numerous, as those of Tillandsia. The
cultivation of all the species is perfectly easy, as they require no particular
soil, or management, if kept in the hot-house; where they grow luxuriantly
and throw out, from the roots, abundance of suckers; which should be taken
off, to encourage the flowering of the central shoot.
PLATE CCL.
IXIA COLUMNARIS. Var. grandiflora.
Columnar-chived Ixia. Large flowered Var.
CLASS III. ORDER I.

TRIANDRIA MONOGYNIA. Three Chives. One Pointal.
Corolla sex-petala, patens, æqualis. Stigmata tria, erectiusculo-patula.

Blossom six petals, spreading, equal. Summits three, upright-spreading.
See Ixia reflexa, Pl. XIV. Vol. I.
SPECIFIC CHARACTER.
Ixia filamentis basi cohærentibus; floribus subcapitatis corollis purpureo-

violaceis, maximis.
Ixia with threads united at the base; flowers grow nearly headed:
blossoms purple violet, very large.
1. The two valves of the sheath.

2. An intire flower cut open in the tube only, which is extended
nearly to the end of the threads.
3. The Chives cut open, magnified.
4. The Pointal complete, one of the Summits detached and
magnified.
5. The Seed-vessel cut across.
We have nothing farther to fay upon this fine variety of the Columnar-
chived Ixia than what has been said on the other varieties of this species; but,
that it was introduced from Holland with the changeable coloured variety in

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After reading this chapter, students should be able to:

◆ Describe how risk aversion affects a stock’s required rate of return.

Chapter 8: Risk and Rates of Return Learning Objectives 183

DAYS ON CHAPTER: 3 OF 56 DAYS (50-minute periods)

184 Lecture Suggestions Chapter 8: Risk and Rates of Return

8-2 a. The probability distribution for complete certainty is a vertical line.

Chapter 8: Risk and Rates of Return Answers and Solutions 185

186 Answers and Solutions Chapter 8: Risk and Rates of Return

8-1 r̂ = (0.1)(-50%) + (0.2)(-5%) + (0.4)(16%) + (0.2)(25%) + (0.1)(60%)

2 = (-50% – 11.40%)2(0.1) + (-5% – 11.40%)2(0.2) + (16% – 11.40%)2(0.4)

8-2 Investment Beta

bp = ($35,000/$75,000)(0.8) + ($40,000/$75,000)(1.4) = 1.12.

8-3 rRF = 6%; rM = 13%; b = 0.7; r = ?

r = rRF + (rM – rRF)b

8-4 rRF = 5%; RPM = 6%; rM = ?

8-5 a. r = 11%; rRF = 7%; RPM = 4%.

r = rRF + (rM – rRF)b

Chapter 8: Risk and Rates of Return Answers and Solutions 187

r = rRF + (rM – rRF)b

r̂Y = 0.1(-35%) + 0.2(0%) + 0.4(20%) + 0.2(25%) + 0.1(45%)

σ 2X = (-10% – 12%)2(0.1) + (2% – 12%)2(0.2) + (12% – 12%)2(0.4)

X = 12.20% versus 20.35% for Y.

CVX = X/ r̂ X = 12.20%/12% = 1.02, while

CVY = 20.35%/14% = 1.45.

$400,000 $600,000 $1,000,000 $2,000,000

rp = rRF + (rM – rRF)(bp) = 6% + (14% – 6%)(0.7625) = 12.1%.

rRF = 6% and (rM – rRF) = 8%.

Stock Investment Beta r = rRF + (rM – rRF)b Weight

rp = 18%(0.10) + 2%(0.15) + 16%(0.25) + 12%(0.50) = 12.1%.

188 Answers and Solutions Chapter 8: Risk and Rates of Return

rJ = rRF + (rM – rRF)b

8-9 We know that bR = 1.50, bS = 0.75, rM = 13%, rRF = 7%.

ri = rRF + (rM – rRF)bi = 7% + (13% – 7%)bi.

The difference in their required returns is:

8-11 rRF = r* + IP = 2.5% + 3.5% = 6%.

8-12 a. ri = rRF + (rM – rRF)bi = 9% + (14% – 9%)1.3 = 15.5%.

Chapter 8: Risk and Rates of Return Answers and Solutions 189

ri = rRF + (rM – rRF)bi = 10% + (15% – 10%)1.3 = 16.5%.

2. rRF decreases to 8%:

ri = rRF + (rM – rRF)bi = 8% + (13% – 8%)1.3 = 14.5%.

8-13 a. Using Stock X (or any stock):

b. bQ = 1/3(0.8) + 1/3(1.2) + 1/3(1.6)

New portfolio beta = 0.95(1.1263) + 0.05(1.75) = 1.1575  1.16.

New portfolio beta = (22.4 – 1.0 + 1.75)(0.05) = 1.1575  1.16.

190 Answers and Solutions Chapter 8: Risk and Rates of Return

8-15 bHRI = 1.8; bLRI = 0.6. No changes occur.

rRF = 6%. Decreases by 1.5% to 4.5%.

rM = 13%. Falls to 10.5%.

Now SML: ri = rRF + (rM – rRF)bi.