Chapter5RiskandReturn109

Solutions to Problems
P51.

LG1:Rateofreturn: rt =

(Pt Pt 1 Ct )
Pt1

Basic
a.

InvestmentX:Return

($21,000 $20,000 $1,500)

12.50%
$20,000

($55, 000 $55, 000 $6,800)

12.36%
$55, 000
b. InvestmentXshouldbeselectedbecauseithasahigherrateofreturnforthesamelevel
ofrisk.
InvestmentY:Return

P52.

LG1:Returncalculations: rt =

(Pt Pt 1 Ct )
Pt1

Basic
Investment

P53.

Calculation

rt(%)

($1,100$800$100)$800

25.00

($118,000$120,000$15,000)$120,000

10.83

($48,000$45,000$7,000)$45,000

22.22

($500$600$80)$600

3.33

($12,400$12,500$1,500)$12,500

11.20

LG1:Riskpreferences
Intermediate
a.

TheriskindifferentmanagerwouldacceptInvestmentsXandYbecausethesehavehigher
returnsthanthe12%requiredreturnandtheriskdoesntmatter.
b. TheriskaversemanagerwouldacceptInvestmentXbecauseitprovidesthehighestreturn
andhasthelowestamountofrisk.InvestmentXoffersanincreaseinreturnfortakingon
moreriskthanwhatthefirmcurrentlyearns.
c. TheriskseekingmanagerwouldacceptInvestmentsYandZbecauseheorsheiswillingto
takegreaterriskwithoutanincreaseinreturn.
d. Traditionally,financialmanagersareriskaverseandwouldchooseInvestmentX,sinceit
providestherequiredincreaseinreturnforanincreaseinrisk.

110GitmanPrinciplesofManagerialFinance,Twelfth Edition

P54.

LG2:Riskanalysis
Intermediate
a.
Expansion

Range

24%16%8%

30%10%
20%

b. ProjectAislessrisky,sincetherangeofoutcomesforAissmallerthantherangefor
ProjectB.
c. Sincethemostlikelyreturnforbothprojectsis20%andtheinitialinvestmentsareequal,the
answerdependsonyourriskpreference.
d. Theanswerisnolongerclear,sinceitnowinvolvesariskreturntradeoff.ProjectBhasa
slightlyhigherreturnbutmorerisk,whileAhasbothlowerreturnandlowerrisk.
P55.

LG2:Riskandprobability
Intermediate
a.
Camera

Range

30%20%10%

35%15%20%

b
Possible
Outcomes
CameraR

CameraS

c.

Probability
Pri

ExpectedReturn
ri

Weighted
Value(%)(ri
Pri)

Pessimistic

0.25

20

5.00

Mostlikely

0.50

25

12.50

Optimistic

0.25

30

7.50

1.00

Expectedreturn

25.00

Pessimistic

0.20

15

3.00

Mostlikely

0.55

25

13.75

Optimistic

0.25

35

8.75

1.00

Expectedreturn

25.50

CameraSisconsideredmoreriskythanCameraRbecauseithasamuchbroaderrangeof
outcomes.TheriskreturntradeoffispresentbecauseCameraSismoreriskyandalso
providesahigherreturnthanCameraR.

Chapter5RiskandReturn111

P56.

LG2:Barchartsandrisk
Intermediate
a.

112GitmanPrinciplesofManagerialFinance,Twelfth Edition

b.
Market
Acceptance
LineJ

Probability
Pri

WeightedValue
(riPri)

VeryPoor

0.05

0.0075

0.000375

Poor

0.15

0.0125

0.001875

Average

0.60

0.0850

0.051000

Good

0.15

0.1475

0.022125

Excellent

0.05

0.1625

0.008125

1.00
LineK

ExpectedReturn
ri

Expectedreturn

0.083500

VeryPoor

0.05

0.010

0.000500

Poor

0.15

0.025

0.003750

Average

0.60

0.080

0.048000

Good

0.15

0.135

0.020250

Excellent

0.05

0.150

0.007500

1.00

Expectedreturn

0.080000

C
.

P57.

LineKappearslessriskyduetoaslightlytighterdistributionthanlineJ,indicatingalower
rangeofoutcomes.

LG2:Coefficientofvariation: CV

r
r

Basic
7%
0.3500
20%
9.5%
B CVB
0.4318
22%
6%
C CVC
0.3158
19%
5.5%
D CVD
0.3438
16%
b. AssetChasthelowestcoefficientofvariationandistheleastriskyrelativetotheotherchoices.
a.

P58.

A CVA

LG2:Standarddeviationversuscoefficientofvariationasmeasuresofrisk
Basic
a. ProjectAisleastriskybasedonrangewithavalueof0.04.
b. ProjectAisleastriskybasedonstandarddeviationwithavalueof0.029.Standarddeviation
isnottheappropriatemeasureofrisksincetheprojectshavedifferentreturns.

Chapter5RiskandReturn113

c.

P59.

0.029
0.2417
0.12
0.032
B CVB
0.2560
0.125
0.035
C CVC
0.2692
0.13
0.030
D CVD
0.2344
0.128
InthiscaseProjectDisthebestalternativesinceitprovidestheleastamountofriskforeach
percentofreturnearned.Coefficientofvariationisprobablythebestmeasureinthisinstance
sinceitprovidesastandardizedmethodofmeasuringtheriskreturntradeoffforinvestments
withdifferingreturns.
A CVA

LG2:Personalfinance:Rateofreturn,standarddeviation,coefficientofvariation
Challenge
a.

StockPrice
Year
2006
2007
2008
2009

Beginning

End

b.

14.36
21.55
21.55
64.78
64.78
72.38
72.38
91.80
Averagereturn

c.

Sumofvariances

Variance
Returns
50.07%
200.60%
11.73%
26.83%
72.31%

(ReturnAverageReturn)2
0.0495
1.6459
0.3670
0.2068
2.2692
3

Sampledivisor(n1)

0.7564

Variance

86.97%
d.
e.

1.20

Standarddeviation
Coefficientofvariation

ThestockpriceofApplehasdefinitelygonethroughsomemajorpricechangesoverthis
timeperiod.Itwouldhavetobeclassifiedasavolatilesecurityhavinganupwardprice
trendoverthepast4years.NotehowcomparingsecuritiesonaCVbasisallowstheinvestor
toputthestockinproperperspective.ThestockisriskierthanwhatMikenormallybuys
butifhebelievesthatApplewillcontinuetorisethenheshouldincludeit.

114GitmanPrinciplesofManagerialFinance,Twelfth Edition

P510. LG2:Assessingreturnandrisk
Challenge
a.

Project257
(1) Range:1.00(.10)1.10
n

(2) Expectedreturn: r ri Pri

i =1

ExpectedReturn
RateofReturn
ri

Probability
Pr i

.10
0.10
0.20
0.30
0.40
0.45
0.50
0.60
0.70
0.80
1.00

WeightedValue
ri Pr i

i 1

0.001
0.004
0.010
0.030
0.060
0.135
0.075
0.060
0.035
0.032
0.010

0.01
0.04
0.05
0.10
0.15
0.30
0.15
0.10
0.05
0.04
0.01

1.00
(3) Standarddeviation:

(r r )
i 1

r ri Pri

0.450
2

Pri

ri r

( ri r ) 2

Pr i

( ri r ) 2Pr i

0.10
0.10

0.450

0.550

0.3025

0.01

0.003025

0.450

0.350

0.1225

0.04

0.004900

0.20

0.450

0.250

0.0625

0.05

0.003125

0.30

0.450

0.150

0.0225

0.10

0.002250

0.40

0.450

0.0025

0.15

0.000375

0.45
0.50
0.60
0.70
0.80
1.00

0.450
0.450
0.450
0.450
0.450
0.450

0.050
0.000
0.050
0.150
0.250
0.350
0.550

0.0000
0.0025
0.0225
0.0625
0.1225
0.3025

0.30
0.15
0.10
0.05
0.04
0.01

0.000000
0.000375
0.002250
0.003125
0.004900
0.003025

ri

0.027350

Project 257 0.027350 0.165378

Chapter5RiskandReturn115

0.165378
0.3675
0.450

(4) CV

b. Project432
(1) Range:0.500.100.40
n

(2) Expectedreturn: r ri Pri

i 1

ExpectedReturn
RateofReturn
ri

Probability
Pr i

WeightedValue
ri Pri

0.10

0.05

0.0050

0.15

0.10

0.0150

0.20

0.10

0.0200

0.25

0.15

0.0375

0.30

0.20

0.0600

0.35

0.15

0.0525

0.40

0.10

0.0400

0.45

0.10

0.0450

0.50

0.05

0.0250

r ri Pri
i =1

1.00

0.300

(r r )

(3) Standarddeviation:

i 1

Pri

ri

ri r

( ri r ) 2

Pri

( ri r ) 2Pri

0.10

0.300

0.20

0.0400

0.05

0.002000

0.15

0.300

0.15

0.0225

0.10

0.002250

0.20

0.300

0.10

0.0100

0.10

0.001000

0.25

0.300

0.05

0.0025

0.15

0.000375

0.30

0.300

0.00

0.0000

0.20

0.000000

0.35

0.300

0.05

0.0025

0.15

0.000375

0.40

0.300

0.10

0.0100

0.10

0.001000

0.45

0.300

0.15

0.0225

0.10

0.002250

0.50

0.300

0.20

0.0400

0.05

0.002000
0.011250

Project432 0.011250 0.106066

(4) CV

0.106066
0.3536
0.300

116GitmanPrinciplesofManagerialFinance,Twelfth Edition

c.

BarCharts

d. Summarystatistics
Project257

Project432

Range

1.100

0.400

Expectedreturn (r )

0.450

0.300

Standarddeviation ( r )

0.165

0.106

Coefficientofvariation(CV)

0.3675

0.3536

SinceProjects257and432havedifferingexpectedvalues,thecoefficientofvariationshould
bethecriterionbywhichtheriskoftheassetisjudged.SinceProject432hasasmallerCV,it
istheopportunitywithlowerrisk.

Chapter5RiskandReturn117

P511. LG2:Integrativeexpectedreturn,standarddeviation,andcoefficientofvariation
Challenge
a.

Expectedreturn: r ri Pri
i 1

ExpectedReturn
Probability
Pr i

WeightedValue
ri Pri

0.40

0.10

0.04

0.10

0.20

0.02

0.00

0.40

0.00

0.05

0.20

0.01

0.10

0.10

0.01

RateofReturn
ri
AssetF

r ri Pri
i 1

0.04

AssetG

0.35

0.40

0.14

0.10

0.30

0.03

0.20

0.30

0.06

0.11

AssetH

0.40

0.10

0.04

0.20

0.20

0.04

0.10

0.40

0.04

0.00

0.20

0.00

0.20

0.10

0.02

0.10

AssetGprovidesthelargestexpectedreturn.

118GitmanPrinciplesofManagerialFinance,Twelfth Edition

b. Standarddeviation:

(r r )
i 1

AssetF

AssetG

AssetH

xPri

ri r

( ri r ) 2

Pr i

0.40 0.04 0.36

0.1296

0.10

0.01296

0.10 0.04 0.06

0.0036

0.20

0.00072

0.00 0.040.04

0.0016

0.40

0.00064

0.05 0.040.09

0.0081

0.20

0.00162

0.10 0.040.14

0.0196

0.10

0.00196

0.01790

0.1338

0.35 0.11 .24

0.0576

0.40

0.02304

0.10 0.110.01

0.0001

0.30

0.00003

0.20 0.110.31

0.0961

0.30

0.02883

0.05190

0.2278

0.40 0.10 .30

0.0900

0.10

0.009

0.20 0.10 .10

0.0100

0.20

0.002

0.10 0.10 0.00

0.0000

0.40

0.000

0.00 0.100.10

0.0100

0.20

0.002

0.20 0.100.30

0.0900

0.10

0.009

0.022

0.1483

Basedonstandarddeviation,AssetGappearstohavethegreatestrisk,butitmustbe
measuredagainstitsexpectedreturnwiththestatisticalmeasurecoefficientofvariation,since
thethreeassetshavedifferingexpectedvalues.Anincorrectconclusionabouttheriskofthe
assetscouldbedrawnusingonlythestandarddeviation.
c.

Coefficientofvariation =

standarddeviation( )
expectedvalue

0.1338
3.345
0.04
0.2278
AssetG: CV
2.071
0.11
0.1483
AssetH: CV
1.483
0.10
Asmeasuredbythecoefficientofvariation,AssetFhasthelargestrelativerisk.
AssetF: CV

Chapter5RiskandReturn119

P512. LG2:Normalprobabilitydistribution
Challenge
a.

Coefficientofvariation:CV r r

Solvingforstandarddeviation: 0.75r0.189
r0.750.1890.14175
b. (1) 68%oftheoutcomeswillliebetween1standarddeviationfromtheexpectedvalue:
1 0.189 0.14175 0.33075
1 0.189 0.14175 0.04725
(2) 95%oftheoutcomeswillliebetween2standarddeviationsfromtheexpectedvalue:
2 0.189 (2 0.14175) 0.4725
2 0.189 (2 0.14175) 0.0945
(3) 99%oftheoutcomeswillliebetween3standarddeviationsfromtheexpectedvalue:
3 0.189 (3 0.14175) 0.61425
3 0.189 (3 0.14175) 0.23625
c.

Return

120GitmanPrinciplesofManagerialFinance,Twelfth Edition

P513. LG3:Personalfinance:Portfolioreturnandstandarddeviation
Challenge
a.

Expectedportfolioreturnforeachyear:rp(wLrL)(wMrM)

Year

AssetL
(wLrL)

2010

(14%0.405.6%)

(20%0.6012.0%)

17.6%

2011

(14%0.405.6%)

(18%0.6010.8%)

16.4%

2012

(16%0.406.4%)

(16%0.609.6%)

16.0%

2013

(17%0.406.8%)

(14%0.608.4%)

15.2%

2014

(17%0.406.8%)

(12%0.607.2%)

14.0%

2015

(19%0.407.6%)

(10%0.606.0%)

13.6%

b. Portfolioreturn:

rp

rp
c.

j 1

AssetM
(wMrM)

Expected
PortfolioReturn
rp

rj

n
17.6 16.4 16.0 15.2 14.0 13.6
15.467 15.5%
6

Standarddeviation: rp

(ri r )2
i 1 ( n 1)
n

(17.6% 15.5%)2 (16.4% 15.5%)2 (16.0% 15.5%)2

(15.2% 15.5%)2 (14.0% 15.5%)2 (13.6% 15.5%)2

rp
6 1
(2.1%)2 (0.9%)2 (0.5%)2

2
2
2
(0.3%) (1.5%) (1.9%)
rp
5

rp

(.000441 0.000081 0.000025 0.000009 0.000225 0.000361)

5

0.001142
0.000228% 0.0151 1.51%
5
d. Theassetsarenegativelycorrelated.
e. Combiningthesetwonegativelycorrelatedassetsreducesoverallportfoliorisk.

rp

Chapter5RiskandReturn121

P514. LG3:Portfolioanalysis
Challenge
a.

Expectedportfolioreturn:
Alternative1:100%AssetF
rp

16% 17% 18% 19%

17.5%
4

Alternative2:50%AssetF50%AssetG
Year

AssetF
(wFrF)

AssetG
(wGrG)

PortfolioReturn
rp

2010

(16%0.508.0%)

(17%0.508.5%)

16.5%

2011

(17%0.508.5%)

(16%0.508.0%)

16.5%

2012

(18%0.509.0%)

(15%0.507.5%)

16.5%

2013

(19%0.509.5%)

(14%0.507.0%)

16.5%

rp

16.5% 16.5% 16.5% 16.5%

16.5%
4

Alternative3:50%AssetF50%AssetH
Year

AssetF
(wFrF)

AssetH
(wHrH)

PortfolioReturn
rp

2010

(16%0.508.0%)

(14%0.507.0%)

15.0%

2011

(17%0.508.5%)

(15%0.507.5%)

16.0%

2012

(18%0.509.0%)

(16%0.508.0%)

17.0%

2013

(19%0.509.5%)

(17%0.508.5%)

18.0%

rp

15.0% 16.0% 17.0% 18.0%

16.5%
4

b. Standarddeviation: rp

(ri r )2

i 1 ( n 1)
n

(1)

[(16.0% 17.5%)2 (17.0% 17.5%)2 (18.0% 17.5%)2 (19.0% 17.5%)2 ]

4 1

[( 1.5%)2 (0.5%)2 (0.5%)2 (1.5%)2 ]

3

(0.000225 0.000025 0.000025 0.000225)

3

0.0005
.000167 0.01291 1.291%
3

122GitmanPrinciplesofManagerialFinance,Twelfth Edition

(2)

FG

[(16.5% 16.5%)2 (16.5% 16.5%)2 (16.5% 16.5%)2 (16.5% 16.5%)2 ]

4 1

FG

[(0)2 (0)2 (0)2 (0)2 ]

3

FG 0
(3)

c.

FH

[(15.0% 16.5%)2 (16.0% 16.5%)2 (17.0% 16.5%)2 (18.0% 16.5%)2 ]

4 1

FH

[( 1.5%)2 (0.5%)2 (0.5%)2 (1.5%)2 ]

3

FH

[(0.000225 0.000025 0.000025 0.000225)]

3

FH

0.0005
0.000167 0.012910 1.291%
3

Coefficientofvariation:CV r r
1.291%
0.0738
17.5%
0

0
16.5%
1.291%

0.0782
16.5%

CVF
CVFG
CVFH

d. Summary:
rp:ExpectedValue
ofPortfolio

rp

CVp

Alternative1(F)

17.5%

1.291%

0.0738

Alternative2(FG)

16.5%

Alternative3(FH)

16.5%

1.291%

0.0
0.0782

Sincetheassetshavedifferentexpectedreturns,thecoefficientofvariationshouldbeusedto
determinethebestportfolio.Alternative3,withpositivelycorrelatedassets,hasthehighest
coefficientofvariationandthereforeistheriskiest.Alternative2isthebestchoice;itis
perfectlynegativelycorrelatedandthereforehasthelowestcoefficientofvariation.

Chapter5RiskandReturn123

P515. LG4:Correlation,risk,andreturn
Intermediate
a.

(1) Rangeofexpectedreturn:between8%and13%
(2) Rangeoftherisk:between5%and10%

b. (1) Rangeofexpectedreturn:between8%and13%
(2) Rangeoftherisk:0risk10%
c.

(1) Rangeofexpectedreturn:between8%and13%
(2) Rangeoftherisk:0risk10%

P516. LG1,4:Personalfinance:Internationalinvestmentreturns
Intermediate
24,750 20,500 4,250

0.20732 20.73%
20,500
20,500

a.

Returnpesos

b.

Purchaseprice
Salesprice

c.

Priceinpesos
20.50

$2.22584 1,000shares $2,225.84

Pesosperdollar 9.21

Priceinpesos
24.75

$2.51269 1,000shares $2,512.69

Pesosperdollar 9.85

Returnpesos

2,512.69 2,225.84
286.85

0.12887 12.89%
2,225.84
2,225.84

d. Thetworeturnsdifferduetothechangeintheexchangeratebetweenthepesoandthedollar.
Thepesohaddepreciation(andthusthedollarappreciated)betweenthepurchasedateandthe
saledate,causingadecreaseintotalreturn.Theanswerinpart(c)isthemoreimportantof
thetworeturnsforJoe.Aninvestorinforeignsecuritieswillcarryexchangeraterisk.
P517. LG5:Total,nondiversifiable,anddiversifiablerisk
Intermediate
aandb

124GitmanPrinciplesofManagerialFinance,Twelfth Edition

c.

Onlynondiversifiableriskisrelevantbecause,asshownbythegraph,diversifiableriskcan
bevirtuallyeliminatedthroughholdingaportfolioofatleast20securitiesthatarenotpositively
correlated.DavidTalbotsportfolio,assumingdiversifiableriskcouldnolongerbereduced
byadditionstotheportfolio,has6.47%relevantrisk.

P518. LG5:Graphicderivationofbeta
Intermediate
a.

b. Toestimatebeta,theriseoverrunmethodcanbeused: Beta

Rise Y

Run X

Takingthepointsshownonthegraph:
BetaA

Y 12 9 3

0.75
X 8 4 4

Y 26 22 4

1.33
X 13 10 3
Afinancialcalculatorwithstatisticalfunctionscanbeusedtoperformlinearregression
analysis.Thebeta(slope)oflineAis0.79;oflineB,1.379.
Withahigherbetaof1.33,AssetBismorerisky.Itsreturnwillmove1.33timesforeachone
pointthemarketmoves.AssetAsreturnwillmoveatalowerrate,asindicatedbyitsbeta
coefficientof0.75.
BetaB

c.

P519. LG5:Interpretingbeta
Basic
Effectofchangeinmarketreturnonassetwithbetaof1.20:
a. 1.20(15%) 18.0%increase
b. 1.20(8%) 9.6%decrease
c. 1.20(0%) nochange
d. Theassetismoreriskythanthemarketportfolio,whichhasabetaof1.Thehigherbeta
makesthereturnmovemorethanthemarket.

Chapter5RiskandReturn125

P520. LG5:Betas
Basic
aandb
Asset

Beta

Increasein
MarketReturn

0.50

0.10

1.60

C
D

ExpectedImpact
onAssetReturn

Decreasein
MarketReturn

Impacton
AssetReturn

0.05

0.10

0.05

0.10

0.16

0.10

0.16

0.20

0.10

0.02

0.10

0.02

0.90

0.10

0.09

0.10

0.09

c. AssetBshouldbechosenbecauseitwillhavethehighestincreaseinreturn.
d. AssetCwouldbetheappropriatechoicebecauseitisadefensiveasset,movinginopposition
tothemarket.Inaneconomicdownturn,AssetCsreturnisincreasing.
P521. LG5:Personalfinance:Betasandriskrankings
Intermediate
a.
Mostrisky
Leastrisky

Stock

Beta

1.40

0.80

0.30

bandc

Asset

Beta

Increasein
MarketReturn

ExpectedImpact
onAssetReturn

Decreasein
MarketReturn

Impacton
AssetReturn

0.80

0.12

0.096

0.05

0.04

1.40

0.12

0.168

0.05

0.07

0.30

0.12

0.036

0.05

0.015

d. Inadecliningmarket,aninvestorwouldchoosethedefensivestock,StockC.Whilethe
marketdeclines,thereturnonCincreases.
e. Inarisingmarket,aninvestorwouldchooseStockB,theaggressivestock.Asthemarket
risesonepoint,StockBrises1.40points.

126GitmanPrinciplesofManagerialFinance,Twelfth Edition
n

P522. LG5:Portfoliobetas:bp w j b j
j 1

Intermediate
a.
PortfolioA

PortfolioB

Asset

Beta

wA

wAbA

wB

wBbB

1.30

0.10

0.130

0.30

0.39

0.70

0.30

0.210

0.10

0.07

1.25

0.10

0.125

0.20

0.25

1.10

0.10

0.110

0.20

0.22

0.90

0.40

0.360

0.20

0.18

bA 0.935

bB

1.11

b. PortfolioAisslightlylessriskythanthemarket(averagerisk),whilePortfolioBismore
riskythanthemarket.PortfolioBsreturnwillmovemorethanPortfolioAsforagiven
increaseordecreaseinmarketreturn.PortfolioBisthemorerisky.
P523. LG6:Capitalassetpricingmodel(CAPM):rjRF[bj(rmRF)]
Basic
rj

8.9%

5% [1.30(8%5%)]

12.5%

8% [0.90(13%8%)]

8.4%

9% [0.20(12%9%)]

15.0%

10% [1.00(15%10%)]

8.4%

6% [0.60(10%6%)]

Case

RF[bj(rmRF)]

P524. LG5,6:Personalfinance:Betacoefficientsandthecapitalassetpricingmodel
Intermediate
TosolvethisproblemyoumusttaketheCAPMandsolveforbeta.Theresultingmodelis:
Beta
a.
b.
c.
d.

r RF
rm RF

10% 5% 5%

0.4545
16% 5% 11%
15% 5% 10%
Beta

0.9091
16% 5% 11%
18% 5% 13%
Beta

1.1818
16% 5% 11%
20% 5% 15%
Beta

1.3636
16% 5% 11%
Beta

Chapter5RiskandReturn127

e.

IfKatherineiswillingtotakeamaximumofaverageriskthenshewillbeabletohavean
expectedreturnofonly16%.(r5%1.0(16%5%)16%.)

P525. LG6:ManipulatingCAPM:rjRF[bj(rmRF)]
Intermediate
rj
rj
b. 15%
RF
c. 16%
rm
d. 15%
bj
a.

8%[0.90(12%8%)]
11.6%
RF[1.25(14%RF)]
10%
9%[1.10(rm9%)]
15.36%
10%[bj(12.5%10%)
2

P526. LG1,3,5,6:Personalfinance:Portfolioreturnandbeta
Challenge
a.

bp(0.20)(0.80)(0.35)(0.95)(0.30)(1.50)(0.15)(1.25)
0.160.33250.450.18751.13

b. rA

c.

($20,000 $20,000) $1,600 $1,600

8%
$20,000
$20,000

rB

($36,000 $35,000) $1,400 $2,400

6.86%
$35,000
$35,000

rC

($34,500 $30,000) 0 $4,500

15%
$30,000
$30,000

rD

($16,500 $15,000) $375 $1,875

12.5%
$15,000
$15,000

rP

($107,000 $100,000) $3,375 $10,375

10.375%
$100,000
$100,000

d. rA4%[0.80(10%4%)]8.8%
rB4%[0.95(10%4%)]9.7%
rC4%[1.50(10%4%)]13.0%
rD4%[1.25(10%4%)]11.5%
e.

Ofthefourinvestments,onlyC(15%versus13%)andD(12.5%versus11.5%)hadactual
returnsthatexceededtheCAPMexpectedreturn(15%versus13%).Theunderperformance
couldbeduetoanyunsystematicfactorthatwouldhavecausedthefirmnotdoaswellas
expected.Anotherpossibilityisthatthefirmscharacteristicsmayhavechangedsuchthatthe
betaatthetimeofthepurchaseoverstatedthetruevalueofbetathatexistedduringthatyear.
Athirdexplanationisthatbeta,asasinglemeasure,maynotcaptureallofthesystematic
factorsthatcausetheexpectedreturn.Inotherwords,thereiserrorinthebetaestimate.

128GitmanPrinciplesofManagerialFinance,Twelfth Edition

P527. LG6:Securitymarketline,SML
Intermediate
a,b,andd

c.

rjRF[bj(rmRF)]
AssetA
rj0.09[0.80(0.130.09)]
rj0.122
AssetB

rj0.09[1.30(0.130.09)]
rj0.142
d. AssetAhasasmallerrequiredreturnthanAssetBbecauseitislessrisky,basedonthebeta
of0.80forAssetAversus1.30forAssetB.ThemarketriskpremiumforAssetAis3.2%
(12.2%9%),whichislowerthanAssetBsmarketriskpremium(14.2%9%5.2%).
P528. LG6:Shiftsinthesecuritymarketline
Challenge
a,b,c,d

Chapter5RiskandReturn129

b. rjRF[bj(rmRF)]
rA8%[1.1(12%8%)]
rA8%4.4%
rA12.4%
c.

rA6%[1.1(10%6%)]
rA6%4.4%
rA10.4%

d. rA8%[1.1(13%8%)]
rA8%5.5%
rA13.5%
e.

(1) Adecreaseininflationaryexpectationsreducestherequiredreturnasshowninthe
paralleldownwardshiftoftheSML.
(2) Increasedriskaversionresultsinasteeperslope,sinceahigherreturnwouldberequired
foreachlevelofriskasmeasuredbybeta.

P529. LG6:Integrativerisk,return,andCAPM
Challenge
a.
Project

rj

RF[bj(rmRF)]

rj

9%[1.5(14%9%)]

16.5%

rj

9%[0.75(14%9%)]

12.75%

rj

9%[2.0(14%9%)]

19.0%

rj

9%[0(14%9%)]

9.0%

rj

9%[(0.5)(14%9%)]

6.5%

bandd

130GitmanPrinciplesofManagerialFinance,Twelfth Edition

c.

ProjectAis150%asresponsiveasthemarket.
ProjectBis75%asresponsiveasthemarket.
ProjectCistwiceasresponsiveasthemarket.
ProjectDisunaffectedbymarketmovement.
ProjectEisonlyhalfasresponsiveasthemarket,butmovesintheoppositedirectionasthe
market.

d. SeegraphfornewSML.
rA9%[1.5(12%9%)]
rB9%[0.75(12%9%)]
rC9%[2.0(12%9%)]
rD9%[0(12%9%)]
rE9%[0.5(12%9%)]
e.

13.50%
11.25%
15.00%
9.00%
7.50%

ThesteeperslopeofSMLbindicatesahigherriskpremiumthanSMLdforthesemarket
conditions.Wheninvestorriskaversiondeclines,investorsrequirelowerreturnsforany
givenrisklevel(beta).

P530. Ethicsproblem
Intermediate
Onewayistoaskhowthecandidatewouldhandleahypotheticalsituation.Onemaygaininsight
intothemoral/ethicalframeworkwithinwhichdecisionsaremade.Anotherapproachistousea
pencilandpaperhonestytestthesearesurprisinglyaccurate,despitetheobviousnotionthatthe
jobcandidatemayattempttogametheexambygivingtherightversustheindividuallyaccurate
responses.Beforeevenadministeringthesituationalinterviewquestionorthetest,askthecandidate
tolistthepreferredattributesofthetypeofcompanyheorsheaspirestoworkfor,andseeif
characterandethicstermsemergeinthedescription.Somecompaniesdocredithistorychecks,after
gainingthecandidatesapprovaltodoso.Usingallfourofthesetechniquesallowsonetotriangulate
towardavalidanddefensibleappraisalofacandidateshonestyandintegrity.