Case Study 13 Instructions
Southeastern Specialty, Inc.: Financial Risk
There is no spreadsheet for this case. Answer ONLY the questions here, NOT the questions in the casebook, even though many are similar. Do not get worried about Question 9 in the casebook; will not cover efficient markets in this course.
Here is some basic calculated data to use in the questions below, derived from Exhibit 13.1:
Investment Expected Return (Mean) SD CV |
T-Bill 7.0% 0.0% 0.00 |
Project A 13.5% 11.7% 0.87 |
Project B 8.8% 9.1% 1.03 |
S&P 500 15.0% 16.4% 1.10 |
SSI 10.0% 5.5% 0.55 |
SD = Standard Deviation
CV = Coefficient ...view middle of the document...
Assume that SSI forms a two-asset portfolio by investing in projects A and B at $5 million EACH (50/50).
a. What would be the portfolio’s expected rate of return (mean), standard deviation, and coefficient of variation? HINT: Create another column in Exhibit 13.1, representing ‘Portfolio AB’. For that column, calculate the Estimated Return on Investment (ERI) for each economic state. Given a 50/50 portfolio, the ERI is simply the average between Project A and Project B for each economic state. This will give you the raw data for calculating the portfolio’s mean, SD and CV. Show your work!
b. How do these values compare with the corresponding values for the individual projects?
c. What characteristic of the two return distributions (i.e., A and B) makes risk reduction possible?
5. Now, imagine a ‘50/50’ portfolio of Project A and the S&P 500 Fund. Would this portfolio have the same effect on risk as the portfolio in Question 4? Why or why not?
6. Please answer all parts of Question 6 in the casebook, pp 103-104.
7. The market risk (i.e., market beta coefficient) for the 1-yr. T-Bill is zero; for Project A, it is 0.70; for Project B, it is -0.39; and for SSI, it is 0.33. These are calculated by plotting five years of each asset’s returns against the market (i.e., the S&P 500). See Question 7 in the casebook to discover how Exhibit 13.1 can be altered to reflect this scenario. The market beta for each investment is really just the slope of a regression line drawn through the five data points for each investment.
d. What is the significance of these betas; that is, what do they say about each investment relative to the market? (HINT: what does a positive slope mean? A negative slope? No slope?)
e. The T-Bill and SSI regression lines lie directly on the data points. What does this tell you about the level of diversifiable risk?
f. Projects A and B have some data points that do not lie on their regression lines. What does...