Chapter 6 - P14

a. Use the data given to calculate annual returns for Bartman, Reynolds, and the Market Index, and then calculate average returns
year period. (Hint: Remember, returns are calculated by subtracting the beginning price from the ending price to get the capital ga
adding the dividend to the capital gain or loss, and dividing the result by the beginning price. Assume that dividends are already incl
index. Also, you cannot calculate the rate of return for 2005 because you do not have 2004 data.)

Data as given in the problem are shown below:

Bartman Industries Reynolds Incorporated
Year Stock Price Dividend Stock Price
2010 $17.250 $1.150 $48.750
2009 14.750 1.060 52.300
2008 16.500 1.000 48.750
2007 10.750 0.950 57.250
2006 11.375 0.900 60.000
2005 7.625 0.850 55.750

We now calculate the rates of return for the two companies and the index:

Bartman Reynolds Index

2010 24.7% -1.1% 32.8%
2009 -4.2% 13.2% 1.2%
2008 62.8% -10.0% 34.9%
2007 2.9% -0.4% 14.8%
2006 61.0% 11.7% 19.0%

Average 29.4% 2.7% 20.6%

Note: To get the average, you could get the column sum and divide by 5, but you could also use the function wizard, fx. Click fx, then statist
Average, and then use the mouse to select the proper range. Do this for Bartman and then copy the cell for the other items.

b. Calculate the standard deviation of the returns for Bartman, Reynolds, and the Market Index. (Hint: Use the sample standard d
formula given in the chapter, which corresponds to the STDEV function in Excel.)

Use the function wizard to calculate the standard deviations.

Bartman Reynolds
Standard deviation of returns 31.5% 9.7%

Sort the companies by their stand-alone risk: Bartman is the riskiest while Reynolds isnt as risky

c. Now calculate the coefficients of variation Bartman, Reynolds, and the Market Index.

Bartman Reynolds
Coefficient of Variation 1.07 3.63
Which company is riskier now? Reynolds is riskier than bartman when looking at it this way

d. Construct a scatter diagram graph that shows Bartmans and Reynolds returns on the vertical axis and the Market Indexs retu
horizontal axis.

It is easiest to make scatter diagrams with a data set that has the X-axis variable in the left column, so we reformat the returns data
calculated above and show it just below.

Year Index Bartman Reynolds

2010 32.8% 24.7% -1.1%
2009 1.2% -4.2% 13.2%
2008 34.9% 62.8% -10.0%
2007 14.8% 2.9% -0.4%
2006 19.0% 61.0% 11.7%

Chart Title
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%
-10.0%
-20.0%

Bartman Linear (Bartman)

Reynolds Linear (Reynolds)

To make the graph, we first selected the range with the returns and the column heads, then clicked the chart wizard, then choose the scatter d
connected lines. That gave us the data points. We then used the drawing toolbar to make free-hand ("by eye") regression lines, and changed
and weights to match the dots.

Which company has a positive beta? bartman

Which company has a negative beta? reynolds

e. Estimate Bartmans and Reynoldss betas as the slopes of regression lines with stock returns on the vertical axis (y-axis) and mar
the horizontal axis (x-axis). (Hint: use Excels SLOPE function.) Are these betas consistent with your graph?

Bartman's beta = 1.54

Reynolds' beta = -0.56

Are these beta values consistent with the scatter graph?

definittly, reynolds is negitivly corilated to the market; while bartman is positivly correlated.

f. The risk-free rate on long-term Treasury bonds is 6.04%. Assume that the market risk premium is 5%. What is the expected retu
SML equation to calculate the two companies' required returns.
Market risk premium (RPM) = 5.000%
Risk-free rate = 6.040%

Expected return on market = Risk-free rate +

= 6.040% +
= 11.040%

Required return = Risk-free rate +

Bartman:
Required return = 6.040%
= 13.736560787954400%

Reynolds:
Required return = 6.040%
= 3.2377135171644400%

Explain the rationale of investing in Reynolds:

Reynolds is almost like a garentee that even if the market goes down they should do good; therefore if your portfolio had shares of reynolds a

g. If you formed a portfolio that consisted of 50% Bartman stock and 50% Reynolds stock, what would be its beta and its required

The beta of a portfolio is simply a weighted average of the betas of the stocks in the portfolio, so this portfolio's beta
would be:

Portfolio beta = 0.49

h. Suppose an investor wants to include Bartman Industries stock in his or her portfolio. Stocks A, B, and C are currently in the po
their betas are 0.769, 0.985, and 1.423, respectively. Calculate the new portfolios required return if it consists of 25% of Bartman, 1
A, 40% of Stock B, and 20% of Stock C.

Beta Portfolio Weight

Bartman 1.539 25%
Stock A 0.769 15%
Stock B 0.985 40%
Stock C 1.423 20%
100%
Portfolio Beta = 1.179

Required return on portfolio: = Risk-free rate +

= 6.04%
= 11.93%
ket Index, and then calculate average returns over the five-
ice from the ending price to get the capital gain or loss,
price. Assume that dividends are already included in the
004 data.)

Reynolds Incorporated Market Index

Dividend Includes Divs.
$3.000 11,663.98
2.900 8,785.70
2.750 8,679.98
2.500 6,434.03
2.250 5,602.28
2.000 4,705.97

use the function wizard, fx. Click fx, then statistical, then
py the cell for the other items.

rket Index. (Hint: Use the sample standard deviation

Index
13.8%

Reynolds isnt as risky

Index
0.67
an when looking at it this way

the vertical axis and the Market Indexs returns on the

lumn, so we reformat the returns data

% 30.0% 35.0% 40.0%

(Bartman)
(Reynolds)

icked the chart wizard, then choose the scatter diagram without
e-hand ("by eye") regression lines, and changed the lines color

k returns on the vertical axis (y-axis) and market return on

stent with your graph?

isk premium is 5%. What is the expected return on the market? Now use the
 Market risk premium
5.000%

Market Risk Premium x Beta

5.000% 1.539

5.000% -0.560

erefore if your portfolio had shares of reynolds and the market went down your losses should be partially offset by the gains of reynolds. Kinda like hedgin

tock, what would be its beta and its required return?

o, so this portfolio's beta

io. Stocks A, B, and C are currently in the portfolio, and

ired return if it consists of 25% of Bartman, 15% of Stock

Market Risk Premium * * Beta

5.00% 1.179
reynolds. Kinda like hedging, or insurance.
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.79734799
R Square 0.63576382
Adjusted R Sq 0.51435176
Standard Erro 0.06768672
Observations 5

ANOVA
df SS MS F Significance F
Regression 1 0.02399059 0.02399059 5.23641416 0.10611997
Residual 3 0.01374448 0.00458149
Total 4 0.03773506

Coefficients Standard Error t Stat P-value Lower 95%

Intercept 0.14196267 0.05874493 2.41659427 0.09445672 -0.04498993
X Variable 1 -0.5604573 0.24492072 -2.28832125 0.10611997 -1.33990435
ificance F

Upper 95% Lower 95.0% Upper 95.0%

0.32891527 -0.04498993 0.32891527
0.21898975 -1.33990435 0.21898975
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.67547226
R Square 0.45626278
Adjusted R Sq 0.27501704
Standard Erro 0.26812111
Observations 5

ANOVA
df SS MS F Significance F
Regression 1 0.18097111 0.18097111 2.51737104 0.21078988
Residual 3 0.21566679 0.07188893
Total 4 0.3966379

Coefficients Standard Error t Stat P-value Lower 95%

Intercept -0.02202765 0.23270085 -0.09466083 0.93055253 -0.76258561
X Variable 1 1.53931216 0.97018171 1.58662253 0.21078988 -1.54823904
ificance F

Upper 95% Lower 95.0% Upper 95.0%

0.7185303 -0.76258561 0.7185303
4.62686336 -1.54823904 4.62686336