Corporate Finance Risk and Return - Assignment Example

Expected return for each investment for the next period. Expected returns Sealy Ltd Expected return Gas Ltd Expected return Space Ltd Expected return -4.00% -264.3% -6.54% -167% -10.46% -172% 6.57% 40.1826% 4.35% 56% 7.50% 28% 9.21% 24.8643% 6.78% 43% 9.60% 31% 11.50% 9.71% 12.54% Standard deviation Sealy Ltd standard deviation Gas Ltd standard deviation Space Ltd standard deviation -4.00% 5.7% -6.54% 5.79% -10.46% 9.00% 6.57% 2.0% 4.35% 2.19% 7.50% 2.07% 9.21% 1.1% 6.78% 1.47% 9.60% 1.47% 11.50% 9.71% 12.54% Question two Fromm the above analysis, an investor should consider investment in Sealy limited under investment returns of 9.2% since, this stock depict high expected returns and low risk as measured by the standard deviations. The implication is that high expected returns and low standard deviation would be good for an investors since, standard deviation is a measure of risk on investment hence, an ideal investment opportunity is the one that would lead to high returns (As measured by expected return) and low risk (as measured by standard deviation)[Jam151]. 3. Correlation coefficient between Sealy and Gas Sealy Ltd Gas Ltd Correlation  Sealy Ltd Gas Ltd -4.00% -6.54% Sealy Ltd 1 6.57% 4.35% Gas Ltd 1.0 1 9.21% 6.78% 11.50% 9.71% From the above analysis, it can be observed that there is a strong correlation of 1 which implies that the two securities for Gas and Sealy ltd is much correlated. Sealy and Gas and Space Sealy Ltd Gas Ltd Space Ltd   Sealy Ltd Gas Ltd Space Ltd -4.00% -6.54% -10.46% Sealy Ltd 1 6.57% 4.35% 7.50% Gas Ltd 1.0 1.0 9.21% 6.78% 9.60% Space Ltd 1.0 1.0 1 11.50% 9.71% 12.54% From the above analysis, it can be observed that there is a strong correlation of 1 between Sealy and Gas and Space. The correlation implies that, an investor should hold a diversified portfolio since, it is apparent that holding portfolio between Sealy, Gas and Space ltd would lead to increased returns and reduction in overall investment risk as much as the combination of the security is volatile. 4. The expected return and standard deviation of a two-asset portfolio comprised of Sealy and Gas shares Sealy Ltd Expected return Weight Weighted Returns Gas Ltd Expected return Weight Weighted Returns 6.57% 40.18% 61.8% 24.8% 4.35% 56% 56.6% 31.68% 9.21% 24.86% 38.2% 9.5% 6.78% 43% 43.4% 18.68% 11.50% 65.05%     9.71% 99%                     Portfolio Expected Weighted returns Sealy Ltd  Gas Ltd     Weighted Returns Weighted Returns Portfolio Weighted returns   24.8% 31.68% 56.5%   9.5% 18.68% 28.2%   Therefore, portfolio expected returns shall be Sealy Ltd Expected return Weight Weighted Returns Space Ltd Expected return Weight Weighted Returns Portfolio Expected returns 6.57% 40.18% 61.8% 24.8% 7.50% 28% 47% 13.3% 38.1% 9.21% 24.86% 38.2% 9.5% 9.60% 31% 53% 16.3% 25.8% 11.50% 65.05%     12.54% 59%       Portfolio Standard deviation Sealy Ltd Sealy Ltd Expected return standard deviation Weight Weighted standard deviation 6.57% 40.2% 2.0% 61.8% 1.2% 9.21% 24.9% 1.1% 38.2% 0.4% 11.50% 65.05%       Gas Ltd         Gas Ltd standard deviation Weight Weighted standard deviation 4.35% 2.80% 60.9% 2% 6.78% 1.47% 60.9% 1% Portfolio Weighted standard deviation Weighted standard deviation(Sealy Ltd) Weighted standard deviation(Gas Ltd) Portfolio Weighted standard deviation 1.4% 2% 4.5% 0.2% 1% 1.2% Sealy and Space shares Sealy Ltd Expected return Weight Weighted Returns Space Ltd Expected return Weight Weighted Returns 6.57% 40.18% 61.8% 24.8% 7.50% 28% 47% 13.3% 9.21% 24.86% 38.2% 9.5% 9.60% 31% 53% 16.3% 11.50% 65.05%     12.54% 59%                     Portfolio Expected returns Sealy Ltd Expected return Weight Weighted Returns Space Ltd Expected return Weight Weighted Returns Portfolio Expected returns 6.57% 40.18% 61.8% 24.8% 7.50% 28% 47% 13.3% 38.1% 9.21% 24.86% 38.2% 9.5% 9.60% 31% 53% 16.3% 25.8% 11.50% 65.05%     12.54% 59%       Portfolio Expected returns and standard Deviation Sealy Ltd Expected return standard deviation Weight Weighted standard deviation Space Ltd standard deviation Weight Weighted standard deviation 6.57% 40.2% 2.0% 61.8% 1.2% 7.50% 2.07% 76.6% 2% 9.21% 24.9% 1.1% 38.2% 0.4% 9.60% 1.47% 76.6% 1% Weighted standard deviation(Sealy Ltd) Weighted standard deviation(Space Ltd) Portfolio Weighted standard deviation 1.2% 2% 3.3%% 0.% 1% 1.% Gas and Space shares Portfolio Expected Returns Gas Ltd Expected return Weight Weighted return 4.35% 56% 56.6% 31.68% 6.78% 43% 43.4% 18.68% 9.71% 99%             Space Ltd Expected return Weight Weighted return 7.50% 28% 47% 13.3% 9.60% 31% 53% 16.3% 12.54% 59%             Portfolio Weighted Returns       Gas Ltd 31.68%       18.68%     Space Ltd         13.3%       16.3%     Portfolio Weighted Returns 79.93%     Portfolios Standard Deviation         Portfolio Standard Deviation       Space Ltd Standard Deviation Weight Weighted Standard Deviation 7.50% 2.07% 76.6% 2% 9.60% 1.47% 76.6% 1% 12.54%               Gas Ltd Standard Deviation Weight Weighted Standard Deviation 4.35% 2.80% 60.9% 2% 6.78% 1.47% 60.9% 1% 11.13%               Portfolio Standard Deviation       Space Ltd 2%       1%             Gas Ltd 2%       1%     Portfolio Standard Deviation 6%     From the above analysis, it is apparent that it is efficient to hold a portfolio since, it is apparent from the above calculation that weighted portfolio would lead to a drastic decline in portfolio standard deviation to 6% and a high return of 79.94% unlike holding a single postilion investment. In this regards, a risk averse investors must ensure that he/she invest in a diversified portfolio since, it will lead to an increase in return on investment with a reduction in risk as observed in the above working[Tom13]. 5. The expected return and standard deviation of a three-asset portfolio comprised of Sealy, Gas and Space shares Sealy Ltd Gas Ltd Space Ltd Expected Return 6.57% 4.35% 7.50% 190.71% 9.21% 6.78% 9.60% Standard Deviation 11.50% 9.71% 12.54% 0.008 From the above calculation, it can be observed that combination of three portfolios would lead to a drastic decline in risk as measured by the standard deviation to 0.008 and an increase in returns as measured by the standard deviation to 190.7%. The implication is that, an increase in asset diversification, would lead to a further decline in risk and growth in returns. 6. The average return, variance and standard deviation for Air Technologies Ltd, Mineral Resources Ltd and the Market index   Average Return Variance Standard Deviation Air Technologies Ltd (%) 2.941 36.43 6.04 Share Market index (%) 2.94 36.43 6.04 Mineral Resources Ltd (%) 3.12 41.34 6.43 7. Systematic risk (Beta) of both Air Technologies and Mineral Resources Ltd. Beta=COVARIANCE.P (equity price array, index price array)/VAR.P (index price array) Systematic Risk Month Share Market index (%) Air Technologies Ltd (%)   Mineral Resources Ltd (%) 1 5.08 2.37 2.05 2 5.08 1.37 Beta for Air tech 4.9 Beta for Mineral ltd 3 5.5 1.3 21.8 -1.5 17.8 4 1.19 7.71 Slope 7.37 slope 5 -1.79 -1.14 0.60 -7.26 0.81 6 -1.62 -1.51 -3.7 7 -1.13 -6.29 -6.42 8 5.09 3.88 9.87 9 -8.1 -5.26 -3.47 10 2.84 1.61 3.17 11 1.7 2.12 5.12 12 2.74 5.9 8.58 13 6.03 10.83 8.81 14 5.71 10.31 9.84 15 8.64 8.37 2.12 16 11 12.64 7.67 17 -2.49 -4.31 -7.72 18 7.9 2.22 12.83 19 -7.25 -8.51 -1.84 20 1.88 3.76 3.44 21 6.17 9.47 1.31 22 -3.67 -5.99 -2.23 23 2.08 8.93 7.42 24 1.56 10.81 2.1 A Beta (β) measures the volatility of a stock as compared to the market such as the S$P 500. It is a vital tool that appraises the security risks. It therefore appraises the market risk in entirety while standard deviation appraises the risk of specific security. It is an appraisal of the dispersion of data set from the mean where the more the dispersion from the mean, the higher the deviation. Standard deviation is the square root of variance. From our Analysis, We appraised beta by finding the slope of the linear trend line developed by plotting the benchmark return against the equity return. Beta shall be same as the slope of the trend. It can therefore be observed that beta for Air technologies and Mineral resources ltd is 0.6 and 0.81 respectively which is less than 1 implying that our security is less volatile as compared to the markets which therefore ideal for investment[Jam151]. 8. Using the capital asset pricing model to calculate the required rate of return for both Air Technologies and Mineral resources Ltd Risk free rate of return is 3% The capital asset pricing model can be defined as ‘a model for ascertaining the risk premium on a security. The model discloses that returns which match to risks are gained under the situation that the capital market upholds balance CAPM is given as ra = rrf + Ba (rm-rrf) where: rrf = the required rate of return rm = The market expected return Ba = Beta of the security Expected return = Risk free rate + Beta * (Market Risk Premium)  Air Technologies Ltd (%) CAPM=3%+0.6(2.9-3%) =2.94% Mineral Resource Ltd CAPM=3%+0.81(2.6-3%) =2.68% Required rate of return is the minimal rate earned by a venture that will encourage an investor to spend more in a stock. From the above analysis, it is apparent that the required rate of returns for Air technologies and Mineral resource ltd is 2.94% and 2.68% respectively. The rate of return is very high implying that the security of these two companies is viable for investment since; a positive return will be realized within the shortest time. 9. The present value for both Companies Present value for Air technology Air Technologies Ltd Mineral Resources Ltd $2.10 $3.00 $2.12 $3.06 $2.15 $3.10 $2.19 $3.14 $2.22 $3.18 $2.25 $3.22 Growth rate in dividend is worked out using the following formula Dn dividend paid in the current year Dn-1 is dividend paid last year N is the number of years Air Technologies start Dividend $2.10 End dividend $2.25 Growth rate {2.25-2.1/2.1}= 1.25 Po={$2.25/2.94%-1.25%}=$1.33 Mineral Resource start Dividend $3.00 End dividend $3.22 Growth rate (3.33-3/3) 2.22 Po={$3.22/2.68%-2.22}=$7 Assumption Made No external factors will affect the dividend growth rate since, the financial projection is short There shall be a constant growth rate in dividend per share for the next 6 years Reference list Jam151: , (Cloonan, 2015), Tom13: , (Tom K. Lloyd, 2013), Read More