PART 2: VALUATION, RISK AND RETURN
b Now suppose that you buy 400 shares of SNP, but you finance this purchase with $5,000 of your
own funds and $5,000 that you raise by selling short 100 shares of Nader Insurance Inc. Nader
Insurance shares currently sell for $50, but next year you expect them to be worth $52. This
implies an expected return of 4%. If both shares perform as you expect, how much money will
you have at the end of the year after you repurchase 100 Nader shares at the market price and
return them to your broker? What rate of return on your $5,000 investment does this represent?
c Suppose you buy 400 shares of SNP and finance them as described in part (b). However, at the
end of the year SNP shares are worth $31. What was the percentage increase in SNP shares?
What is the rate of return on your portfolio (again, after you repurchase Nader shares and return
them to your broker)?
d Finally, assume that at the end of one year, SNP shares have fallen to $24. What was the rate of
return on SNP shares for the year? What is the rate of return on your portfolio?
e What is the general lesson illustrated here? What is the impact of short selling on the expected
return and risk of your portfolio?
P7-16 You are given the following data on several shares:State of the economy Probability Returns in each state of economy
Gere Mining Reubenfeld Films DeLorean Automotive
Boom 25% 40% 24% –20%
Expansion 50% 12% 10% 12%
Recession 25% –20% –12% –40%a Calculate the expected return and standard deviation for each share.
b Calculate the expected return and standard deviation for a portfolio invested equally in Gere
Mining and Reubenfeld Films. How does the standard deviation of this portfolio compare to a
simple 50–50 weighted average of the standard deviations of the two shares?
c Calculate the expected return and standard deviation for a portfolio invested equally in Gere
Mining and DeLorean Automotive. How does the standard deviation of this portfolio compare
to a simple 50–50 weighted average of the standard deviations of the two shares?
d Explain why your answers regarding the portfolio standard deviations are so different in
parts (b) and (c).
P7-17 In an odd twist of fate, the return on the share market has been exactly 1% in each of the last eight
months. The return on Simon Entertainment shares in the past eight months has been as follows:
8%, 4%, 16%, –10%, 26%, 22%, 1%, –55%. From this information, estimate the beta of Simon shares.P7-18 Petro-Chem Pty Ltd.’s share has a beta equal to 0.9. Digi-Media Corp.’s share beta is 2.0. What is
the beta of a portfolio invested equally in these two shares?PUTTING IT ALL TOGETHER: THE CAPM
P7-19 The risk-free rate is currently 3%, and the expected risk premium on the market portfolio is 6%.
What is the expected return on a share with a beta of 1.1?P7-20 The expected return on the market portfolio equals 12%. The current risk-free rate is 6%. What is
the expected return on a share with a beta of 0.66?
P7-21 The expected return on a particular share is 14%. The share’s beta is 1.5. What is the risk-free rate if
the expected return on the market portfolio equals 10%?
P7-22 If the risk-free rate equals 4% and a share with a beta of 0.75 has an expected return of 10%, what is
the expected return on the market portfolio?