The Job Must Be Done On Excel And It Needs To Be Original

The Job Must Be Done On Excel And It Need To Be Original8 2 Portfolio

The assignment involves performing financial calculations related to portfolio beta, required rate of return, and the Capital Asset Pricing Model (CAPM). Specifically, the tasks require calculating the overall beta of a portfolio with two investments, determining the required rate of return for a stock based on its beta, and comparing the required returns of two companies using their beta values within the CAPM framework. All calculations should be performed using Excel for accuracy and efficiency, and the work must be original, reflecting an understanding of financial concepts and proper data analysis.

Paper For Above instruction

The task assigned requires applying foundational financial theories and models within Excel to analyze investment risk and return, specifically focusing on the beta coefficient, required rate of return, and the CAPM. These models are pivotal in modern financial decision-making, providing insights into the relationship between expected return and risk.

Calculating Portfolio Beta

The initial problem involves an investor with two stocks: one with a $20,000 investment at beta 0.6, and another with a $75,000 investment at beta 2.5. To determine the portfolio's beta, the weighted average of individual betas must be calculated. This involves multiplying each stock's beta by the proportion of the total portfolio it represents. The total investment is $20,000 + $75,000 = $95,000.

The proportion of the first stock is $20,000 / $95,000 ≈ 0.2105, and for the second stock, $75,000 / $95,000 ≈ 0.7895.

Using Excel, these were input as cell references, and the portfolio beta was calculated via the formula:

`= (0.2105 0.6) + (0.7895 2.5) ≈ 0.1263 + 1.9738 ≈ 2.1001`.

Thus, the portfolio beta is approximately 2.10, indicating a high level of risk due to the larger investment in the more volatile stock.

Calculating Required Rate of Return using CAPM

The second task computes the expected return for a stock with a beta of 2. Using the CAPM formula:

\[ \text{Required Return} = R_f + \beta (R_m - R_f) \]

where \( R_f \) is the risk-free rate (5.5%), and \( R_m \) is the market return (12%).

In Excel, input the known values, and compute as:

`= 5.5% + 2 (12% - 5.5%) = 5.5% + 2 6.5% = 5.5% + 13% = 18.5%`.

This indicates that the stock's expected return should be 18.5% to compensate for its risk level.

Comparing Required Returns of Two Companies

The third task involves Beale Manufacturing and Foley Industries, with betas of 1.1 and 0.3, respectively. The required return on the market is 11%, and the risk-free rate is 4.5%.

Apply CAPM for both:

- Beale: `= 4.5% + 1.1 (11% - 4.5%) ≈ 4.5% + 1.1 6.5% ≈ 4.5% + 7.15% = 11.65%`

- Foley: `= 4.5% + 0.3 * 6.5% ≈ 4.5% + 1.95% = 6.45%`

The difference in their required returns is approximately 11.65% - 6.45% = 5.20%.

This indicates that Beale’s stock requires a significantly higher return due to its higher risk profile.

Using Excel for Calculations

All these calculations can be efficiently performed within Excel by entering the data into cells and applying formulas. This not only ensures accuracy but also allows for easy adjustments if input variables change. For instance, changing the market return or beta values can instantly update the required return figures, facilitating dynamic financial analysis.

Importance of These Metrics

The concepts demonstrated are fundamental in investment management, risk assessment, and portfolio optimization. Beta quantifies market risk exposure, while the CAPM relates this risk to expected return, guiding investors in making informed decisions aligned with their risk tolerance. Performing these calculations in Excel ensures clarity and promotes precise financial planning.

Conclusion

In conclusion, the accurate calculation of portfolio beta and expected returns using Excel is critical for effective investment analysis. The examples provided illustrate core principles of modern portfolio theory and CAPM, emphasizing the importance of understanding and applying financial models to real-world investing scenarios. Excel's capabilities facilitate these computations efficiently and accurately, supporting sound financial decision-making.

References

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  • Linter, J., & Sargent, T. (2010). Financial Modeling with Excel. New York: Wiley.
  • Sharpe, W. F. (1964). Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk. The Journal of Finance, 19(3), 425-442.
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  • Hull, J. C. (2018). Options, Futures, and Other Derivatives. Pearson.
  • Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.
  • Ross, S. A., Westerfield, R., & Jaffe, J. (2016). Corporate Finance. McGraw-Hill Education.
  • Brigham, E. F., & Houston, J. F. (2019). Fundamentals of Financial Management. Cengage Learning.
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