Filmore Enterprises Essay Example

be inferred that higher risk leads to higher returns, and vice versa. To choose the preferred solution from multiple "efficient solutions," it is necessary to consider the tradeoff between risk and return. If one portfolio (A) offers greater expected gains and lower risk than another, it dominates A.

The main reason for the differences in table1 among the six assets is due to variations in risks and returns.

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  Adding additional stocks and bonds, such as CPC and EAT, to another portfolio would actually decrease the risk. This reduction can be observed in the CPC-Morely portfolio where the risk decreases.
  
• The composition of the portfolio affects both the expected return and standard deviation. (Please refer to table5-2 provided in the attachment).

Please see table5-2 in the attachment (by PORTSIZE) [pic]. When an investor adds more randomly-selected stocks to their portfolio, it results in a decrease in risk. The graph illustrates that as the number of stocks increases, there is a gradual decline in portfolio standard deviation. As portfolio standard deviation measures risk, this indicates a decreasing level of risk. Diversification can be compared to "don't put all your eggs in one basket." Holding only one stock carries risk; however, investors won't lose all their money due to that single stock. By holding multiple stocks, risk is reduced; however, if a company performs poorly, investors may still face significant losses. Therefore, putting all eggs into one basket could lead to losing everything.

Placing eggs in separate baskets is a strategy that offers more diversification. Investors

who lack diversification may not receive proper compensation for all their risks. Market risk includes potential losses due to fluctuations in market prices, such as equity, currency, commodity, and interest rate risks. Diversified risk involves distributing investments across different assets. Security-specific risk arises from specific circumstances affecting an individual security rather than the overall market.

The text discusses the concept of total risk being the combination of various risk factors associated with investment decision-making. It mentions the significant role of pension funds as shareholders in both listed and private companies, particularly in the stock market where institutional investors have a dominant presence. The text also highlights the diversification benefits offered by different pension funds, especially in the United States. Furthermore, it explains that comparing the slope coefficients in characteristic lines with the provided betas can provide insights. The significance of the difference between plot points and the regression line is discussed, noting that it represents more than just errors. Closer alignment between plot points and the line (which is 1.00) indicates better returns. Additionally, the text explains that beta measures the portion of an asset's statistical variance that cannot be diversified away by a portfolio of multiple risky assets due to their correlation. Beta can be estimated for individual companies through regression analysis against a stock market index, and investors use it to gauge stocks' risk profiles. High-beta stocks are considered riskier but may offer greater potential returns, while low-beta stocks carry less risk but may also yield lower returns.

• See the chart of "Relationship Between Beta and Expected Return of Each Security" on the attachment.

• justify;">From the chart, it is evident that the risk and return relationship appears unreasonable compared to the market. The market value of risk and return is 1.00 and 8.30% respectively, but T-bond, T-bill, and Morely are significantly lower than the market.

Also CPC and EAT have slightly higher values for CPC and EAT but are within the normal range.

• The Security Market Line in the attachment provides additional information.
• Refer to the attachment for the required rate of return for CPC, Morely, and EAT.

Considering the required rate of return from the SML and the expected return from question 1, my choice would be to invest in CPC's and EAT's stocks over others. This is because their expected return values exceed the required rate of return, indicating a higher potential for profits. c. Not all stocks are in equilibrium, meaning their prices are not stable. However, ultimately, a balance between supply and demand leads to an equilibrium state.

To maintain price stability, one strategy is to attract shareholder investment by offering increased profits and investing in positive projects and reports. The beta coefficient for a 40/60 portfolio of CPC-EAT is 1.35, indicating that the required rate of return is higher than the expected return. This means that the expected return will not be sufficient to meet the demands of this portfolio. Additionally, as Filmore Enterprise increases its market shares, the risk decreases but the required return on equity increases. Decreased risk aversion will result in a lower investor requirement for stock returns, leading to increased stock prices. Furthermore,

as risk aversion declines, the historical difference between returns on stocks and bonds will decrease, causing a decline in the risk premium.