Answer the following questions and complete the following problems:

Questions

In a Word document, respond to the following. Number your responses 1–2.

1. Explain why expected return is considered forward-looking. What challenges arise in using expected return?
2. Explain how differences in allocations between the risk-free security and the market portfolio can determine the level of market risk.

Use references to support your responses as needed. Be sure to cite all references using correct APA style. Your responses should be free of grammar and spelling errors, demonstrating strong written communication skills.

Problems

In either a Word document or Excel spreadsheet, complete the following problems.

• You may solve the problems algebraically, or you may use a financial calculator or an Excel spreadsheet.
• If you choose to solve the problems algebraically, be sure to show your computations.
• If you use a financial calculator, show your input values.
• If you use an Excel spreadsheet, show your input values and formulas.

1. 1. Based on the probability and percentage of return for the three economic states in the table below, compute the expected return.

1. If the risk-free rate is 7 percent and the risk premium is 4 percent, what is the required return?
2. Suppose that the average annual return on the Standard and Poor’s 500 Index from 1969 to 2005 was 14.8 percent. The average annual T-bill yield during the same period was 5.6 percent. What was the market risk premium during these 10 years?
3. Conglomco has a beta of 0.32. If the market return is expected to be 12 percent and the risk-free rate is 5 percent, what is Conglomco’s required return? Use the capital asset pricing model (CAPM) to calculate Conglomco’s required return.
4. Calculate the beta of a portfolio that includes the following stocks:
   • Conglomco stock, which has a beta of 3.9 and comprises 35 percent of the portfolio.
   • Supercorp stock, which has a beta of 1.7 and comprises 25 percent of the portfolio.
   • Megaorg stock, which has a beta of 0.3 and comprises 40 percent of the portfolio.

   Estimating Risk and Return Scoring Guide

   CRITERIA	NON-PERFORMANCE	BASIC	PROFICIENT	DISTINGUISHED
   Explain why expected return is considered forward-looking.	Does not explain why expected return is considered forward-looking.	Explains why expected return is considered forward-looking but omits key elements.	Explains why expected return is considered forward-looking.	Analyzes why expected return is considered forward-looking and connects the analysis to relevant real-world examples.
   Identify challenges for practitioners in using expected return.	Does not identify challenges for practitioners in using expected return.	Identifies challenges for practitioners in using expected return but omits key elements.	Identifies challenges for practitioners in using expected return.	Analyzes challenges for practitioners in using expected return and connects the analysis to relevant real-world examples.
   Explain how different allocations between the risk-free security and the market portfolio can achieve any level of desired market risk.	Does not explain how different allocations between the risk-free security and the market portfolio can achieve any level of desired market risk.	Explains how different allocations between the risk-free security and the market portfolio can achieve any level of desired market risk but omits key elements.	Explains how different allocations between the risk-free security and the market portfolio can achieve any level of desired market risk.	Analyzes how different allocations between the risk-free security and the market portfolio can achieve any level of desired market risk and connects the analysis to relevant real-world examples.
   Calculate expected return, considering the possibility of differing economic states.	Does not calculate expected return, considering the possibility of differing economic states.	Calculates expected return, considering the possibility of differing economic states, using inaccurate or incomplete information.	Calculates expected return, considering the possibility of differing economic states.	Calculates expected return, considering the possibility of differing economic states, and explains the calculation.
   Calculate required return, considering the risk-free rate and the risk premium.	Does not calculate required return, considering the risk-free rate and the risk premium.	Calculates required return, considering the risk-free rate and the risk premium, using inaccurate or incomplete information.	Calculates required return, considering the risk-free rate and the risk premium.	Calculates required return, considering the risk-free rate and the risk premium, and explains the calculation.
   Calculate the market risk premium of the Standard and Poor’s 500 Index, showing applicable input values, computational steps, and formulas.	Does not calculate the market risk premium of the Standard and Poor’s 500 Index showing applicable input values, computational steps, and formulas.	Calculates the market risk premium of the Standard and Poor’s 500 Index, showing applicable input values, computational steps, and formulas, using inaccurate or incomplete information.	Calculates the market risk premium of the Standard and Poor’s 500 Index, showing applicable input values, computational steps, and formulas.	Calculates the market risk premium of the Standard and Poor’s 500 Index, showing applicable input values, computational steps, and formulas, and explains the calculations.
   Calculate required return using the capital asset pricing model.	Does not calculate required return using the capital asset pricing model.	Calculates required return using the capital asset pricing model but uses inaccurate or incomplete information.	Calculates required return using the capital asset pricing model.	Calculates required return using the capital asset pricing model and explains the calculation.
   Calculate the beta of a portfolio, showing applicable input values, computational steps, and formulas.	Does not calculate the beta of a portfolio, showing applicable input values, computational steps, and formulas.	Calculates the beta of a portfolio, showing applicable input values, computational steps, and formulas, using inaccurate or incomplete information.	Calculates the beta of a portfolio, showing applicable input values, computational steps, and formulas.	Calculates the beta of a portfolio, showing applicable input values, computational steps, and formulas, and explains the calculation.