MID-ATLANTICSPECIALTY,INC.
FinancialRisk
1. Compare the stand-alone risk/return of each of the five investment alternatives listed in Exhibit13.1.
2. MSI is considering two investment strategies:
-50percentinProjectAand50percentinProjectB(PortfolioA/B) or
-50percentinProjectAand50percentintheS&P500Fund(PortfolioA/S&P). Comparethe riskofthetwoportfolios.Whydoestheriskdiffer?
3.
a.
b.
Comparethe corporateriskofProjectsAandB.(Hint:UsetheexpectedreturnsinExhibit13.1to createagraphwithcorporatecharacteristiclinesforProjectsAand B.Regressionlinescanbe createdusingthe=INTERCEPTand=SLOPEfunctionsinExcel.TheXY(Scatter)chartinExcelis recommended.)
Whatwouldhappento theoverallriskofMSIifitinvestsinProjectA?ProjectB?
4.
a.
b. c.
Comparethe marketriskofa1-yearT-Bill,ProjectA,ProjectB,andequityinMSI.(Hint:UsethehistoricalreturnsinExhibit13.2tocreateagraphwith marketcharacteristiclinesfora1-yearT-Bill, ProjectA,ProjectB,andequityinMSI.)
Whatwouldhappento theoverallriskofawell-diversifiedportfoliowithaninvestmentina1-Year
T-Bill?ProjectA?ProjectB?EquityinMSI?
Whatdoesthedistancebetweenthemarketcharacteristicslineand theexpected returnofan investmentindicate?
5.
a.
b.
Ifyouwereanindividualinvestorwithawell-diversifiedportfolio,whichinvestment(s)inExhibit13.1 wouldyoubuy?Why?(Inreality,MSIisanot-for-profitcorporation,soitwouldbeimpossible tobuy anequityinterestin thefirm.Forthisquestion,assumethatMSIisan investor-ownedcompany.) (Hint:constructaSecurityMarketLinegraphandplottheexpected returnofeachinvestmenton
thegraph.)
WhatdoesthedistancebetweentheSMLandtheexpectedreturnofaninvestmentindicate?
6.
a. b.
c.
Isthereturnontheone-yearT-billriskfree?
SupposeMSIwantstoconstructaportfolioofstocksthathasanexpectedreturnequaltotherisk- freerate.Issuchaportfoliopossible?Issuchaportfoliolikely?
Supposethatyouchoosetoholdasinglestockinvestmentinisolation.Would youbecompensated foralloftheriskthatyouassume?Explain.
7. Inyouropinion,whatarethreekeylearningpointsfromthiscase?
