Portfolio theory
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Kate Nguyen
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Risk and Return in Practice: Problems and Questions 1. In December 1995, Boise Cascade's stock had a beta of 0.95. The treasury bill rate at the time was 5.8%, and the treasury bond rate was 6.4%. The historical risk premium of the Standard&Poor index is 5.5%. The firm had debt outstanding of $ 1.7 billion and a market value of equity of $ 1.5 billion; the corporate marginal tax rate was 36%. a. Estimate the expected return on the stock for a short term investor in the company. b. Estimate the expected return on the stock for a long term investor in the company. c. Estimate the cost of equity for the company. 2. Boise Cascade also had debt outstanding of $ 1.7 billion and a market value of equity of $ 1.5 billion; the corporate marginal tax rate was 36%. The historical risk premium of the Standard&Poor index is 5.5%. a. Assuming that the current beta of 0.95 for the stock is a reasonable one, estimate the unlevered beta for the company. b. How much of the risk in the company can be attributed to business risk and how much to financial leverage risk? 3. Biogen Inc., as biotechnology firm, had a beta of 1.70 in 1995. It had no debt outstanding at the end of that year. a. Estimate the cost of equity for Biogen, if the treasury bond rate is 6.4% and the expected yield of S&P index is 12%. b. What effect will an increase in long term bond rates to 7.5% have on Biogen's cost of equity? c. How much of Biogen's risk can be attributed to business risk? 4. Genting Berhad is a Malaysian conglomerate, with holding in plantations and tourist 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 Stock Market risk premium is expected to 7,5%. a. Estimate the expected return on the stock. b. If you were an international investor, what concerns, if any, would you have about using the beta estimated relative to the Malaysian Index? If you do, how would you modify the beta? 5. You have just done a regression of monthly stock returns of HeavyTech Inc., a manufacturer of heavy machinery, on monthly market returns over the last five years and come up with the following regression: RHeavyTech = 0.5% + 1.2 RM The current T.Bill rate is 3% (It was 5% one year ago). The stock is currently selling for $50, down $4 over the last year, and has paid a dividend of $2 during the last year and expects to pay a dividend of $2.50 over the next year. The NYSE composite has...
Risk and Return in Practice: Problems and Questions
1. In December 1995, Boise Cascade's stock had a beta of 0.95. The treasury bill rate at the
time was 5.8%, and the treasury bond rate was 6.4%. The historical risk premium of the
Standard&Poor index is 5.5%. The firm had debt outstanding of $ 1.7 billion and a market
value of equity of $ 1.5 billion; the corporate marginal tax rate was 36%.
a. Estimate the expected return on the stock for a short term investor in the company.
b. Estimate the expected return on the stock for a long term investor in the company.
c. Estimate the cost of equity for the company.
2. Boise Cascade also had debt outstanding of $ 1.7 billion and a market value of equity of $
1.5 billion; the corporate marginal tax rate was 36%. The historical risk premium of the
Standard&Poor index is 5.5%.
a. Assuming that the current beta of 0.95 for the stock is a reasonable one, estimate the
unlevered beta for the company.
b. How much of the risk in the company can be attributed to business risk and how
much to financial leverage risk?
3. Biogen Inc., as biotechnology firm, had a beta of 1.70 in 1995. It had no debt outstanding at
the end of that year.
a. Estimate the cost of equity for Biogen, if the treasury bond rate is 6.4% and the
expected yield of S&P index is 12%.
b. What effect will an increase in long term bond rates to 7.5% have on Biogen's cost
of equity?
c. How much of Biogen's risk can be attributed to business risk?
4. Genting Berhad is a Malaysian conglomerate, with holding in plantations and tourist
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 Stock Market
risk premium is expected to 7,5%.
a. Estimate the expected return on the stock.
b. If you were an international investor, what concerns, if any, would you have about
using the beta estimated relative to the Malaysian Index? If you do, how would you
modify the beta?
5. You have just done a regression of monthly stock returns of HeavyTech Inc., a
manufacturer of heavy machinery, on monthly market returns over the last five years and
come up with the following regression:
R
HeavyTech
= 0.5% + 1.2 RM
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Portfolio theory

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Kate Nguyen
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Portfolio theory
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