MGT201 Assignment 1 Solution Fall 2020
RISK, RETURN AND INVESTMENT DECISIONS
QUESTION: Investment decisions are supported by various factors including investor choice of risk appetite, return on investment and most important market situation that is backed by supply and demand forces. The supply and demand is reflected in market price of security and guide investor to take a rational decision. Along with market decision, company specific information is also helpful in determining the fair price of investment. Rational investor considers both market and company specific information to choose among different options. Following information is available of three stock and you have to choose two from three securities to construct a portfolio.
PARTICULARS |
STOCK A |
STOCK B |
STOCK C |
Market rate of return |
12% |
13% |
12.5% |
Beta |
0.5 |
1.5 |
1 |
Expected dividend from the next year |
Rs 5 per share |
Rs 3 per share |
Rs 6 per share |
Constant growth rate of dividend |
4% |
6% |
2% |
Market price |
Rs 60 |
Rs 56 |
Rs47 |
*calculate required rate of return for three stock using SML equation, if risk free rate of return is 10%.
*calculate fair value of three stocks using Gordon growth model.
*based on fair price calculation identify whether stocks are undervalued or overvalued, justify your answering with reason.
*considering the above calculation, if you want to construct portfolio of two stock from above mentioned three stocks, which two portfolio you will add in your portfolio and why?
SOLUTION:
So,
Required rate of return using SML equation of stock A= SML ℽ_{A= }ℽ_{RF}+ ( ℽ_{m }- ℽ_{RF })β_{A}
_{ }ℽ_{A}= 10% + (12%-10%)(0.5)
ℽ_{A}=11%
Required rate of return using SML equation of stock B=SML ℽ_{B}= ℽ_{RF+(} ℽ_{M }- ℽ_{RF)} β_{B}
_{ }ℽ_{B}= 10% + (13% - 10%)(1.5)
ℽ_{B}= 14.5%
Required rate of return using SML equation of stock C=SML ℽ_{c}= ℽ_{RF }+ ( ℽ_{M }- ℽ_{RF}) β_{c}
_{ }ℽ_{c =} 10%+ (12.5%-10%)(1)
ℽ_{c = }12.5%
Stock A P_{o}* = Div / [(ℽ_{RF }+ (ℽ_{m }- ℽ_{RF }) A)-g]
=5/[10%+ (12%-10%)(0.5)-4%]
=5/[11%-4%]= 5/7%= Rs 71.42
Stock B P_{o}* = Div / [(ℽ_{RF }+ (ℽ_{m }- ℽ_{RF }) B)-g]
=3/[10%+(13%-10%)(1.5))-6%]
=3/[14.5%-6%]= 3/[8.5%]= Rs 35.29
Stock C P_{o}* = Div / [(ℽ_{RF }+ (ℽ_{m }- ℽ_{RF }) C)-g]
=6/[10%+(12.5%-10%)(1))-2%]
=6/[12.5%-2%]=6/10.5%= Rs 57.14
For stock A
Rs 71.43> Rs 60
Which means fair price > market price
Hence stock A is undervalue.
For stock B
Rs 35.42< RS 56
Which means fair price< market price
Hence stock B is overvalue.
For stock C
Rs 57.14> Rs 47
Which means fair price > market price
Hence stock C is undervalue.
We know that portfolio is X_{A} β_{A}+ X_{B} β_{B}+ X_{C} β_{C}
_{ } And if we get only A and C then it becomes X_{A} β_{A} +X_{C} β_{C}
_{ }Other reason that we should not choose B is that its market value is very high and also its risk is more than A and C as it reaches to 1.5
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Assignment #01 Marks =20Assignment #01 Marks =20
Risk, Return and Investment Decisions
Investment decisions are supported by various factors including investor choice of risk appetite, return on investment and most important the market situation that is backed by supply and demand forces. The supply and demand impact is reflected in the market price of securities and guide investors to take a rational decision. Along with market forces, company specific information is also helpful in determining the fair price of an investment. Rational investors consider both market and company specific information to choose among different investment options. Following information is available for the three stock and you have to choose the two from the three securities to construct a portfolio.
Particulars Stock A Stock B Stock C Market rate of return 12% 13% 12.5% Beta 0.5 1.5 1 Expected dividend for the next year Rs. 5 per share Rs. 3 per share Rs. 6 per share Constant growth rate of dividend 4% 6% 2% Market price Rs. 60 Rs. 56 Rs. 47
Required:
• Calculate required rate of return for three stock using SML Equation, if risk free rate of return is 10%.
• Calculate Fair value of three stocks using Gordon Growth Model.
• Based on fair price calculation, identify whether the stocks are undervalued or overvalued, justify your answer with reasoning.
• Considering the above calculations, if you want to construct the portfolio of two stock from the above mentioned three stock., which two stocks you will add in your portfolio and why?
NOTE: Formula and complete working is mandatory in each part, provide complete calculations in order to avoid marks deduction.
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Solution of Assignment
MGT201-Assignment-1-Solution-Fall-2020
Click on the below link to download the file
MGT201 Assignment 1 Solution Fall 2020
RISK, RETURN AND INVESTMENT DECISIONS
QUESTION: Investment decisions are supported by various factors including investor choice of risk appetite, return on investment and most important market situation that is backed by supply and demand forces. The supply and demand is reflected in market price of security and guide investor to take a rational decision. Along with market decision, company specific information is also helpful in determining the fair price of investment. Rational investor considers both market and company specific information to choose among different options. Following information is available of three stock and you have to choose two from three securities to construct a portfolio.
PARTICULARS |
STOCK A |
STOCK B |
STOCK C |
Market rate of return |
12% |
13% |
12.5% |
Beta |
0.5 |
1.5 |
1 |
Expected dividend from the next year |
Rs 5 per share |
Rs 3 per share |
Rs 6 per share |
Constant growth rate of dividend |
4% |
6% |
2% |
Market price |
Rs 60 |
Rs 56 |
Rs47 |
*calculate required rate of return for three stock using SML equation, if risk free rate of return is 10%.
*calculate fair value of three stocks using Gordon growth model.
*based on fair price calculation identify whether stocks are undervalued or overvalued, justify your answering with reason.
*considering the above calculation, if you want to construct portfolio of two stock from above mentioned three stocks, which two portfolio you will add in your portfolio and why?
SOLUTION:
So,
Required rate of return using SML equation of stock A= SML ℽ_{A=} ℽ_{RF}+ ( ℽ_{m} - ℽ_{RF} )β_{A}
_{ } ℽ_{A}= 10% + (12%-10%)(0.5)
ℽ_{A}=11%
Required rate of return using SML equation of stock B=SML ℽ_{B}= ℽ_{RF+(} ℽ_{M} - ℽ_{RF)} β_{B}
_{ } ℽ_{B}= 10% + (13% - 10%)(1.5)
ℽ_{B}= 14.5%
Required rate of return using SML equation of stock C=SML ℽ_{c}= ℽ_{RF} + ( ℽ_{M} - ℽ_{RF}) β_{c}
_{ }ℽ_{c =} 10%+ (12.5%-10%)(1)
ℽ_{c =} 12.5%
Stock A P_{o}* = Div / [(ℽ_{RF} + (ℽ_{m} - ℽ_{RF} ) A)-g]
=5/[10%+ (12%-10%)(0.5)-4%]
=5/[11%-4%]= 5/7%= Rs 71.42
Stock B P_{o}* = Div / [(ℽ_{RF} + (ℽ_{m} - ℽ_{RF} ) B)-g]
=3/[10%+(13%-10%)(1.5))-6%]
=3/[14.5%-6%]= 3/[8.5%]= Rs 35.29
Stock C P_{o}* = Div / [(ℽ_{RF} + (ℽ_{m} - ℽ_{RF} ) C)-g]
=6/[10%+(12.5%-10%)(1))-2%]
=6/[12.5%-2%]=6/10.5%= Rs 57.14
For stock A
Rs 71.43> Rs 60
Which means fair price > market price
Hence stock A is undervalue.
For stock B
Rs 35.42< RS 56
Which means fair price< market price
Hence stock B is overvalue.
For stock C
Rs 57.14> Rs 47
Which means fair price > market price
Hence stock C is undervalue.
We know that portfolio is X_{A} β_{A}+ X_{B} β_{B}+ X_{C} β_{C}
_{ } And if we get only A and C then it becomes X_{A} β_{A} +X_{C} β_{C}
_{ } Other reason that we should not choose B is that its market value is very high and also its risk is more than A and C as it reaches to 1.5
one more file
MGT201-Assignment-1-Solution-Fall-2020-2
Click on the below link to download the file
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