Peachtree Securities Case
1. The return on a 1-year T-Bond is risk-free since it does not vary
according to the state of the economy. The T-Bond return is
independent of the state of the economy because the estimated return
is 8% at all times. The only possible factor affecting a T-Bond may be
2. If we were only to consider the expected return,
then the S&P 500 appears to be the best investments since it has the
greatest expected return.
3. The standard deviation provides a measurement of the total risk by
examining the tightness of the probability distribution associated
with the different possible outcomes whereas the coefficient of
variation measures risk per unit. The coefficient of variation is a
better measure when investments have different expected returns and
different levels of total risk. When risk is considered, the best
alternative depends on how much risk the investor is willing to take.
The S&P 500 may be the stock with the greatest expected return
therefore is also expected to have the greatest standard deviation
while the other potential investments have lower expected return and
consequently a lower standard deviation.
a) A portfolio between TECO – Gold Hill’s would yield a expected
return of 11.2%, with a standard deviation of 2.9%, and coefficient of
variation of 0.26. Compared to TECO, this portfolio yields a lower
return because Gold Hill’s expected return is low and that brings the
average between the two down. The opposite occurs to Gold Hill’s
expected return because TECO’s expected return brings the portfolio
The correlation between the two investments, offers somewhat of a
reduction if risk.
b) In case the portfolio was 75% Gold Hill the expected return would
decrease because the 8.8% return component would have more weight. If
the portfolio contained 75% of TECO the expected return would increase
since TECO’s expected return would have more weight in this case.
Nevertheless, such reduction in diversification would make risk
increase. The complete table “Risk and returns of portfolios” provides
the different changes.
5. The portfolio between TECO – S&P 500 has an expected return of
14.3% and a standard deviation of 14.1%. In this portfolio the
correlation is greater than the one in the other portfolio because the
risk-reducing effect is much lower than the one in the portfolio TECO
– Gold Hill. (See all the possible combinations on TABLE 2).
a) The portfolio’s risk would decrease if more stocks were. The
correlation between stocks is also relevant.
b) I think investors consider the risk as a whole rather than by
each. Nevertheless, if a big part of a portfolio is made up of a
risky stock, it would make the portfolio more risky as a whole.
c) Total risk is made by Diversifiable (company-specific) risk and
market (non-diversifiable) risk. Unique events to a particular firm