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27 Nov 2019

You have recently been appointed chief investment officer of a major charitable foundation. Its large endowment fund is currently invested in a broadly diversified portfolio of stocks (60 percent) and bonds (40 percent). The foundation

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The Goodsmith Charitable foundation, which is tax-exempt, issued debt last year at 8 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 20% higher; that is, firms that paid 10 percent for debt last year will be paying 12 percent this year. a) if the goodsmith foundation borrowed money this year, what would the after tax cost of debt be, based on its cost last year and the 20% increase? b) if the receipts of the foundation were found to be taxable by the IRS (at a rate of 35% because of the involvement in political activities), what would the aftertax cost of the debt be?

You have been provided the following data on the securities ofthree firms, the market portfolio, and the risk-free asset:

a. Fill in the missing values in the table.(Leave no cells blank - be certain to enter 0 whereverrequired. Do not round intermediate calculations and round youranswers to 2 decimal places, e.g., 32.16.)

Security ExpectedReturn StandardDeviation Correlation* Beta
Firm A .101 .40 .76
Firm B .149 .59 1.31
Firm C .169 .56 .44
The marketportfolio .12 .20
The risk-freeasset .05


*With the market portfolio.

b-1. According to the CAPM, what is the expectedreturn of Firm A's stock? (Do not round intermediatecalculations. Enter your answer as a percent rounded to 2 decimalplaces, e.g., 32.16.)

Expectedreturn ___________

b-2. What is your investment recommendation forsomeone with a well-diversified portfolio?

Buy

or

Sell


b-3. According to the CAPM, what is the expectedreturn of Firm B's stock? (Do not round intermediatecalculations. Enter your answer as a percent rounded to 2 decimalplaces, e.g., 32.16.)

Expected return _____________

b-4. What is your investment recommendation forsomeone with a well-diversified portfolio?

Buy

or

Sell



b-5. According to the CAPM, what is the expectedreturn of Firm C's stock? (Do not round intermediatecalculations. Enter your answer as a percent rounded to 2 decimalplaces, e.g., 32.16.)

Expectedreturn ____________

b-6. What is your investment recommendation forsomeone with a well-diversified portfolio?

Buy

or

Sell

10.2 Stock A has an expected rate of return of 8 percent, a standard deviation of 20 percent, and a market beta of 0.5. Stock B has an expected rate of return of 12 percent, a standard deviation of 15 percent, and a market beta of 1.5. Which investment is riskier? Why? (Hint: Remember that the risk of an investment depends on its context.)

If Investment made on Diversified Portfolio than Stock B is more risky then compared to stock A as per CAPM

Whereas Investment is only on one stock then more risky investment is Stock A as per Coeffient of Variation

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