Brealey Principles 12e

Pr 8-1

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Input variables:
Return Std Dev
Treasury bills .030 .000
Stock P .085 .170
Stock Q .180 .370
Stock R .235 .270
a. split .50
b. split .50
b. perfect positive coefficient 1
b. Perfect negative coefficient -1
b. No correlation coefficient 0

Solution and Explanation:

a.
Standard deviation 8.50%

b.
Perfect positive correlation 32.00%
Perfect negative correlation 5.00%
No correlation 22.90%

Notes:
iew algo versions.
Brealey Principles 12e
Pr 8-2

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Input variables:

In this problem, the answers are the same, the input variables change.
See notes section for input variable requirements.

Solution and Explanation:

a. Portfolio A; Investors prefer the higher return given a stated level of risk.
b. Indeterminate; The selection depends on the investor's level of risk tolerance.
c. Portfolio F; Investors prefer less risk given a stated rate of return.

Notes:
Portfolio A rate of return > Portfolio B rate of return
Portfolio A std dev = Portfolio B std dev

Portfolio C rate of return > Portfolio D rate of return

Portfolio C std dev > Portfolio D std dev

Portfolio E rate of return = Portfolio F rate of return

Portfolio E std dev > Portfolio F std dev
risk tolerance.
Brealey Principles 12e
Pr 8-6

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Input variables:
Beta
Caterpillar 1.68
Dow Chemical 1.63
Ford 1.42
Microsoft .96
Apple .93
Johnson & Johnson .55
Walmart .47
Campbell Soup .37
Consolidated Edison .19
Newmont .00
T-bill rate .04
Market rate of return .09
d. Interest rate .02
e. Interest rate .08

Solution and Explanation:

a.
Johnson & Johnson E(r) 6.75%

b.
Highest E(r) 12.40%

c.
Lowest E(r) 4%

d.
Ford Higher
4% 11.10%
2% 11.94%

e.
Walmart Higher
4% 6.35%
8% 8.47%
lgo versions.
Brealey Principles 12e
Pr 8-8

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Input variables:
Change in GNP 6.7%
Change in energy prices -1.0%
Change in long-term interest rates 3.4%
Risk-free rate 7.1%
a. Correlation to each factor 0
b. Correlation to each factor 1
c. Correlation to energy price 2.4
c. Correlation to GNP and interest rates 0
d. Corrleation to interest rates and GNP 1
d. Correlation to energy prices -1.3

Solution and Explanation:

a.
Expected return 7.10%

b.
Expected return 16.20%

c.
Expected return 4.70%

d.
Expected return 18.50%
Brealey Principles 12e
Pr 8-10

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Input variables:
Johnson & Johnson E(r) .080
Ford E(r) .188
Johnson & Johnson σ .132
Ford σ .310
First ρ12 .00
Second ρ12 .25

Solution and Explanation:

Results: x1 x2 rp σ, p12 = 0 σ, p12 = .25

1 0 8.00% 13.20% 13.20%
.90 .10 9.08% 12.28% 13.01%
.80 .20 10.16% 12.25% 13.52%
.70 .30 11.24% 13.11% 14.66%
.60 .40 12.32% 14.71% 16.30%
.50 .50 13.40% 16.85% 18.30%
.40 .60 14.48% 19.33% 20.57%
.30 .70 15.56% 22.06% 23.01%
.20 .80 16.64% 24.94% 25.59%
.10 .90 17.72% 27.93% 28.26%
.00 1.00 18.80% 31.00% 31.00%
lgo versions.
Brealey Principles 12e
Pr 8-12

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Input variables:
xA .40
xB .60
E(r)A .16
E(r)B .18
σA .18
σB .21
ρAB .40
b. ρAB .00
b. ρAB -.40

Solution and Explanation:

a.
E(r) 17.20%
σ 16.83%

b.
σ 14.51%
σ 11.75%

c.
Mr. Scrooge Superior
algo versions.
Brealey Principles 12e
Pr 8-13

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Input variables:
Year 2010 2011 2012 2013
Ms. Sauros 24.900 -.900 18.600 42.100
S&P 500 17.200 1.000 16.100 33.100
Interest rates .120 .040 .060 .020

Solution and Explanation:

a.
Avg. Return Std Dev Sharpe ratio
Ms. Sauros 19.98 15.61 1.28
S&P 500 16.02 11.51 1.39
Interest rates .05 .04

Ms. Sauros performed worse than the overall market as shown in the Sharpe ratio.

b.
Ms. Sauros beta:

Deviation from
Market Ms. Sauros average market
Year return return return
2010 17.20 24.90 1.18
2011 1.00 -.90 -15.02
2012 16.10 18.60 .08
2013 33.10 42.10 17.08
2014 12.70 15.20 -3.32
Average 16.02 19.98

Variance 105.9
Covariance 142.6
Beta 1.3
 2010 2011 2012 2013
Beta × Market return 23.15 1.35 21.67 44.55
Less: (Beta – 1) × Interest rate .04 .01 .02 .01
23.15 23.11 1.33 21.65 44.54

Given a beta of 1.3 , the return earned on Ms. Sauros investments is

algo versions.

2014
15.200
12.700
.020

in the Sharpe ratio.

Product of
Squared deviation
Deviation from deviation from from
Ms. Sauros average market average
return return returns
4.92 1.39 5.81
-20.88 225.60 313.62
-1.38 .01 -.11
22.12 291.73 377.81
-4.78 11.02 15.87
Total 529.75 712.99
 2014 Average
17.09 21.56
.01 .02
17.09 21.54

investments is insufficient to compensate for the risks assumed.

Brealey Principles 12e
Pr 8-15

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Input variables:
T-bill rate 5.3%
Market rate 11.3%
c. Beta 1.40
d. Beta .66
d. Expected return 8.9%
e. Expected return 13.2%

Solution and Explanation:

b.
Market risk premium 6.00%

c.
Required return 13.70%

d.
Required return 9.26%
NPV Negative

e.
Beta 1.32
Brealey Principles 12e
Pr 8-16

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Input variables:
Bond portfolio E(r) .07
Bond portfolio σ .08
S&P 500 E(r) .13
S&P 500 σ .16
a. T-bill rate .05
b. Weights .50
b. Correlation .3

Solution and Explanation:

a.
Index fund x1 .500
T-bills x2 .500
rp 9.00%
Improvement? Yes

b.
E(r) 10.00%
σ 9.96%
E(r) Increases
σ Increases
Improvement No
Brealey Principles 12e
Pr 8-17

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Input variables:
CF0 -170 million
CF1-10 45 million
Number of years CF1-10 11
Beta 2.1
Risk-free interest rate .03
Market rate .14

Solution and Explanation:

Required return .261
NPV -$11.04
Brealey Principles 12e
Pr 8-19

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Input variables:
Market risk premium .061
Interest rate -.009
Yield spread .047
Risk-free rate .036
Factors:
Interest Yield
Stock Market rate spread
P 1.1 -1.3 -.5
P2 1.1 .0 .2
p3 .3 2.2 .5

Solution and Explanation:

E(r)p 9.13%
E(r)p2 11.25%
E(r)p3 5.80%
algo versions.
Brealey Principles 12e
Pr 8-20

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Input variables:
Market risk premium .071
Interest rate -.004
Yield spread .044
Risk-free rate .06
Factors:
Interest Yield
Stock Market rate spread
P 1.7 -2.7 -.2
P2 1.9 .0 1.0
p3 .3 .5 1.0

Solution and Explanation:

Average market factor 1.300
Average interest rate factor -.733
Average yield factor .600
Return 18.16%
Brealey Principles 12e
Pr 8-21

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Input variables:
Interest rate .030
Market risk premium .060
Size risk premium .036
Book-to-market premium .048
Factors:

Stock Boeing Campbell Dow Apple

Market risk premium 1.22 .72 1.14 1.17
Size risk premium 1.28 -.60 .37 -.48
Book-to-market premium -.85 .23 .22 -.650

Solution and Explanation:

Boeing 10.85%
Campbell Soup 6.26%
Dow 12.23%
Apple 5.17%
Brealey Principles 12e
Pr 8-22

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Input variables:
Microfunds' average annual return .04
Beta size factor 1.10
Beta market .70
Beta book-to-market factor -.20
Factors:

Return on
Return on Book-to-
Market Size Mkt Interest
Year Return Factor Factor Rate
1999 .206 .153 -.342 .047
2000 -.175 -.015 .395 .059
2001 -.152 .186 .187 .038
2002 -.228 .036 .105 .017
2003 .308 .278 .049 .010
2004 .107 .051 .098 .012
2005 .031 -.023 .910 .030
2006 .106 .003 .143 .048
2007 .011 -.081 -.122 .047
2008 -.384 .380 .010 .016

Solution and Explanation:

Book-to-
Market market
Interest risk Size risk risk Expected
Year rate premium premium premium return
1999 .047 .159 .106 -.389 35.27%
2000 .059 -.234 -.074 .336 -25.34%
2001 .038 -.190 .148 .149 3.80%
2002 .017 -.245 .019 .088 -15.12%
2003 .010 .298 .268 .039 50.56%
2004 .012 .095 .039 .086 10.42%
2005 .030 .001 -.053 .880 -20.36%
2006 .048 .058 -.045 .095 2.01%
 2007 .047 -.036 -.128 -.169 -8.52%
2008 .016 -.400 .364 -.006 13.76%

Avg expected return 4.65%

Underperformed

Based on the 3-factor Fama-French model, Microfunds should have

earned an average return of 4.65 percent. Since the fund only
earned an average return of 4 percent, it underperformed .
Brealey Principles 12e
Pr 8-25

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Input variables:
Investment b1 b2
X 1.75 .00
Y -1 2
Z 2 1

Risk premium on factor 1 8.0%

Risk premium on factor 2 12.0%

b. X $520
b. Y $130
b. Z -$390
c. X $208
c. Y $156
c. Z -$104
d. X $416
d. Y $52
d. Z -$208

Solution and Explanation:

a.
Risk premium X 14.00%
Risk premium Y 16.00%
Risk premium Z 28.00%

b.
Weight X 2.00
Weight Y .50
Weight Z -1.50

Sensitivities:
Factor 1 0%
Factor 2 -50%
Risk premium -6.00%

c.
Weight X .80
Weight Y .60
Weight Z -.40

Sensitivities:
Factor 1 .00
Factor 2 .80
Risk premium 9.60%

d.
Weight X 1.60
Weight Y .20
Weight Z -.80

Sensitivities:
Factor 1 1.00
Factor 2 -.40
Risk premium 3.20%