What is the cost of equity capital of Granite

Assignment Help Portfolio Management

Reference no: EM133102180

Question 1: True or false? Explain.
a. Computer stock should have a low beta because one of the major risks of the business is technological.
b. Since stock A has higher expected return and lower variance than stock B, a risk averse investor prefers investment in A to any portfolio composed of stocks A and B.
"c. "There may be some truth in the CAPM model, but over the past year many stocks gave a substantially higher return than the CAPM predicted,
and many others gave a substantially lower return. Therefore the CAPM is not a good model to work with.""
"d. The CAPM implies that if you could find an investment with a negative beta,
its expected return would be less than the interest rate."
e. If a stock lies below the security market line, it is undervalued.

Question 2: Consider the following two stocks and T-Bill:

a. Suppose you buy 50 shares of stock A and 50 shares of stock B. What is the expected return of this portfolio and what is its standard deviation?
(Hint - first calculate what fraction of your investment in A and in B).

b. Suppose that instead of buying 50 shares of stock A and 50 shares of stock B you decided to buy only 25 shares of stock A, 25 shares of stock B, and with the rest of the money buy Treasury bills. What is the expected return of this portfolio and what is its standard deviation.
(Hint: use the result in (a) to calculate the standard deviation of a portfolio composed of half (A+B) and half in T-bill).

Question 3: Consider the following risky portfolios

a. Plot these portfolios on a graph where the x axis is the standard deviation and the y axis is the return.

b. Five of the portfolios are efficient, and three are not. Which are the inefficient ones? Explain.
"c. Suppose you are prepared to tolerate a standard deviation of 25 percent on your portfolio. What is the maximum expected return that you achieve if you cannot borrow or lend?"
"d. What is your optimal strategy if you can borrow or lend at 12% and are prepared to tolerate a standard deviation of 25 percent. What is the maximum expected return that you can achieve? (Hint: think CML)"

Question 4:
"Investing on the CML is considered better than investing in any one particular security.
This question shows the benefits of investing on the CML:"
" Your investment portfolio consists of $1 million invested in only one stock - IBM.
The expected return of the stock is 11% and the standard deviation is 46%. The market portfolio has an expected return of 9% and volatility of 22%. The risk free rate is 5%.
a. Under the CAPM assumptions, what portion of IBM's volatility can be eliminated by investing on the CML while having the same expected return as IBM. What portfolio on the CML should you recommend (i.e., find the weights)?
b. Under the CAPM assumptions, what extra return can you achieve in the market relative to IBM, if you are willing to tolerate a standard deviation of returns similar to IBM. What portfolio on the CML should you recommend (i.e., find the weights)? "

Question 5:
Granite Construction is a public company, traded on NASDAQ.
Granite is considering investing in a new project and wishes to calculate its cost of equity capital.
To do that, Granite is going to use the CAPM.
Below you will find historical monthly returns on Granite and the S&P 500.The current yield on 10-year treasuries is 2%.
Assume that the market risk premium is 6%. What is the cost of equity capital of Granite?

Question 6:

You are currently invested in the Farrallon Fund, a broad-based fund of stocks and other securities with an expected return of 8% and a volatility of 33%. Currently, the risk-free rate is 2%. Your broker suggests that you add a new VC fund to your current portfolio. The VC fund has an expected return of 21% and a volatility of 76%. It has a correlation of 0.19 with the Farrallon Fund. Should you add the VC fund to your portfolio? Explain. (Hint: Assume that the fund is the "market" portfolio).

Here are the steps you need to take:
a. What is the beta of the VC fund with respect to the Farralon fund?
b. Given the beta, what return should you expect to get on the VC fund assuming the CAPM holds?
c. What return do you expect to get? Is this return better than the beta-based return?

Attachment:- Risky portfolios.rar

Reference no: EM133102180

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