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Financial Management

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Introduction

FINANCIAL MANAGEMENT PEACHTREE SECURITIES CASE BY FRANCISCO MURRIETA 4-4-05 1. The return on a 1-year T-Bond is risk-free since it does not vary according to the state of the economy. The T-Bond return is independent of the state of the economy because the estimated return is 8% at all times. The only possible factor affecting a T-Bond may be inflation. 2. (See KEY OUTPUT ) If we were only to consider the expected return, then the S&P 500 appears to be the best investments since it has the greatest expected return. 3. The standard deviation provides a measurement of the total risk by examining the tightness of the probability distribution associated with the different possible outcomes whereas the coefficient of variation measures risk per unit. The coefficient of variation is a better measure when investments have different expected returns and different levels of total risk. When risk is considered, the best alternative depends on how much risk the investor is willing to take. The S&P 500 may be the stock with the greatest expected return therefore is also expected to have the greatest standard deviation while the other potential investments have lower expected return and consequently a lower standard deviation. ...read more.

Middle

(See all the possible combinations on TABLE 2). 6. a) The portfolio's risk would decrease if more stocks were. The correlation between stocks is also relevant. b) I think investors consider the risk as a whole rather than by each. Nevertheless, if a big part of a portfolio is made up of a risky stock, it would make the portfolio more risky as a whole. c) Total risk is made by Diversifiable (company-specific) risk and market (non-diversifiable) risk. Unique events to a particular firm cause the diversifiable risk while factors that affect all companies cause the market risk. The difference between diversifiable and market risk is that diversifiable risk can be reduced by diversifying whereas market risk can not be eliminated. d) No, because the market compensates risk diversification if you don't diversify is your fault and you should be willing to accept the risk. 7. (ATTACHMENT 1,2,3,5) S&P 500 - T-Bonds Equation = S&P 500 = 0.08 + 3.08395284618099E-17 The slope coefficient is 3.08395284618099E-17. R2 = 1. S&P 500 - TECO Equation = S&P 500 = 0.027 + 0.7 TECO The slope coefficient is 0.7. ...read more.

Conclusion

9. If inflation expectations went up by 3% above the estimated, TECO's required rate of return would also have to go up by 3%, therefore the required rate of return for teco would move from 12.2 to 15.2%. An explanation similar to what applies to this case can be found on the power point for the chapter. What happens is that the SML shifts and that causes explains the increment. If investors' risk aversion increased so that the market risk premium rose from 7% to 8%, TECO's required rate of return would increase = 8% + (8%)0.6 = 8% + 4.8% = 12.8% If TECO's beta rose from 0.6 to 1, TECO's required rate of return would increase = 8% + (15% - 8%)1 = 8% + 7% = 15% 10. According to the EMH stocks are always in equilibrium. Investors can never beat the market. Additionally, according to the EMH concept, the expected return of a stock would be the required return of such stock. The concept does not consider plant property and equipment. EMH does affect corporate decisions since according to this concept, stocks are fairly valued because its price it's a reflection of public information. Jack Taylor may consider acquiring personnel with knowledge on EMH because this hypothesis seems to work. ?? ?? ?? ?? 1 ...read more.

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