Corp Investment Analysis Chapter 1

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5.a.        
 Stock TStock B 
 YearReturnReturn – AM(Return – AM)^2ReturnReturn – AM(Return – AM)^2 
 10.190.1360.0184960.080.1360.136 
 20.080.0260.054000000000000010.030.054000000000000010.05400000000000001 
 3-0.12-0.1740.05400000000000001-0.090.054000000000000010.05400000000000001 
 4-0.03-0.084000000000000010.054000000000000010.020.054000000000000010.05400000000000001 
 50.150.095999999999999990.054000000000000010.040.054000000000000010.05400000000000001 
 Sum0.270.0184960.0184960.018496 
a.AM0.054000000000000010.018496 
b.SD0.12820.0092 
c.CV2.370.05 
d.GM0.047573714659381320.018496 
         
 Stock T is desirable as per AM       
 Stock B is preferable as per SD       
 Stock T is desirable as per CV       
 Stock T has more variability than Stock B. Greater the variability of returns, greater the difference in arithmetic an geometric mean       
         
7Possible Rate of ReturnProbability     
 -0.600.05     
 -0.300.2     
 -0.100.1     
 0.200.3     
 0.400.2     
 0.800.15     
         
 Expected Return 0.1600     
         
 Expected return [E(Ri)] on Lauren Computer stock is 16%       
         
         
9U.S. government T-bills  5.50%    
 U.S. government long-term bonds  7.50%    
 U.S. common stocks  11.60%    
         
 Inflation rate = (172 – 160)/160       
 Inflation rate 7.50%     
         
 Real U.S. T-Bill Rate -1.86%     
 Real U.S. L.T. Bond Rate 0.00%     
 Real U.S. Stock Return 3.81%     
         
         
12Nominal Rate on T-bills = (1+0.03)*(1+0.05)-1       
   8.15%     
         
 Risk premium = Stock Return – Nominal T-Bill Rate       
  5.85%      
         
 Alternatively, the risk premium can also be calculated as:       
 Formula: (1+Stock Return)/(q1+Nominal T-Bill Rate)-1 or (1.14)/(1.0815)-1       
 5.41%       
 
 





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