The standard deviation of his portfolio return

Assignment Help Financial Management

Reference no: EM132038681

Mr. Weiss just bought a zero-coupon bond issued by Risky Corp. for $930, with $1000 face value and one year to mature. He believes that the market will be in expansion with probability 0.95 and in recession with probability 0.05. In the event of expansion, Risky Corp. can always repay the debt. In the event of recession, the company would fail to meet its debt obligation. The bondholders would recover nothing and completely lose their investment, should the firm default. A zero-coupon government bond with the same maturity and face value is selling at $970.87. Assume that the government never defaults. The expected value and the standard deviation of the return of the market portfolio are 10% and 40%, respectively. Risky Corps bond return has a correlation of 0.75 with the market portfolio return. Assume that interest is compounded annually.

(1) What is the standard deviation of the return of the Risky Corp. bond? What is the beta of the bond? What would be the equilibrium expected return of the Risky Corp. bond if the CAPM holds? Does Mr. Weiss overvalue or undervalue the bond relative to the CAPM?

(2) Suppose Mr. Weiss changes his mind and sells his Risky Corp. bond. He invests in a portfolio that allocates 60% of the money on the market portfolio, and the other 40% on the government bond. What are the expected value and the standard deviation of his portfolio return? Is his portfolio efficient? Explain.

Please answer both parts with detail.

Reference no: EM132038681

Questions Cloud

Computing net foreign exchange bought : P.J. Chase Stanley Bank holds $77 million in foreign exchange assets and $69 million in foreign exchange liabilities. P.J. Chase Stanley also conducted foreign.

What is the bonds valuation : What is the bonds valuation? What is the bond 1’s current yield?

What is the equivalent annual cost of an oven : What is the equivalent annual cost of an oven if the required rate of return is 10 percent? (Round your answer to whole dollars)

What is the maximum amount pierre should be willing to pay : Pierre Dupont just received a cash gift from his grandfather. He plans to invest in a five-year bond issued by Venice Corp. that pays an annual coupon rate.

The standard deviation of his portfolio return : What are the expected value and the standard deviation of his portfolio return? Is his portfolio efficient? Explain.

Interest rate on the debt : A firm has a cost of equity of 10% with an EBIT of a 100, which currently has no debt. Looking to find the new cost of equity if they changed

What is the difference in monthly payments : "You plan to buy a $400,000 home with a 25% down payment. The bank you want to finance the loan with suggests two options: a 20-year mortgage at 5% APR.

Calculate required rate of return on equity using equation : Pierre Corporation is interested in acquiring Coller Corporation. Coller has 30 million shares outstanding and a target capital structure consisting.

What is the first year contract rate : What is the first year contract rate?

User Account

All Pages