University Finance Assignment: Investment, Risk, and Return

This finance assignment provides detailed solutions to three key questions. The first question involves financial calculations, including present value, future value, and annuity calculations. The second question delves into the concept of shareholder wealth maximization versus profit maximization, exploring risk aversion and its implications. The third question focuses on portfolio analysis, calculating monthly and annual holding period returns for two stocks (CBA and RIO), standard deviations, and expected returns. The assignment also includes the construction of a security market line graph and the calculation of a portfolio's expected return and beta, offering insights into investment decisions. The assignment also provides references to the sources used.

Question 1
a. Number of full payments required = 9
Size of concluding 10th payment is $737.69
Workings
Investment
number Investment amount Interest earned Accumulated investment
0
1 800.00 - 800.00
2 800.00 40.00 1,640.00
3 800.00 82.00 2,522.00
4 800.00 126.10 3,448.10
5 800.00 172.41 4,420.51
6 800.00 221.03 5,441.53
7 800.00 272.08 6,513.61
8 800.00 325.68 7,639.29
9 800.00 381.96 8,821.25
10 737.69 441.06 10,000.00
b. Size of equal monthly payments = $2708
Workings
Lottery winning 200,000.00
Investment 180,000.00
Interest rate 10%
Interest earned in 4 years 72,000.00
Total amount receivable in equal payments 252,000.00
Monthly interest rate 0.833%
Number of payments 180
Size of monthly payments 2,708.00

c. Amount in December 2017 = $50.311.57
Workings
Yearly deposits since 2007 December 4,000.00
Interest rate 5%
Number of deposits 10
Amount remains on December 2017 50,311.57
d. Present value of Mary’s future rights is $147201.74 and sale price of future rights is
$150000.The sale price of rights is more than the present value of future rights hence it is
suggested to Mary that she should sale her future rights for $150,000.
Workings
Total amount receivable in equal payments 20,000.00
Interest rate 6.000%
Number of payments 10
Present value of future rights 147,201.74
e. Cost of annuity = $8244.22
Workings
Total amount receivable in equal payments 1,000.00
Growth rate 10.00%
Number of payments 10
Interest rate 12%

Yea
r Annual investment Present value of investment
1 1,000.00 892.86
2 1,100.00 876.91
3 1,210.00 861.25
4 1,331.00 845.87
5 1,464.10 830.77
6 1,610.51 815.93
7 1,771.56 801.36
8 1,948.72 787.05
9 2,143.59 773.00
10 2,357.95 759.20
cost of the annuity 8,244.22

Question 2
1. Shareholder’s wealth refers to the present value of organization’s wealth that will
appropriate to shareholder either in form of dividends or in form of capital receipt on
stock sell. The concept of Shareholder’s wealth maximization related to the worth of
entity. Shareholder’s wealth maximization is objective towards the increase in the
value of an investment of shareholder (Auerbach, 1979). Shareholder’s wealth
concept considers risk and uncertainty involved in the investments made by
shareholder and time involved from the purchase of investment made by a
shareholder to the sale of investment made by the shareholder. This concept put the
focus on achievement of long term objectives. This concept provides strength to the
market stock price of company’s share. For example: if organization targeted towards
the stock price maximization or market value of organization then the organization is
following Shareholder’s wealth maximization concept.
On the other hand, profit maximization is a purely economic concept and does not
consider the risk in the investments and time involved from purchase of investment to
sale of an investment. This theory only considers profit during the period. This
concept put the focus on achievement of short term objectives. This concept provides
operating efficiency to the organization. For example: If an organization targeted
towards the profit of the current year then that organization is following the target of
profit maximization.
The concept of shareholder’s wealth maximization is far batter then the concept of
profit maximization because it considers the market valuation of the organization and
targeted towards organization’s value maximization. Wealth maximization concept
covers the time value of money concept risk and uncertainty involved in every
investment but profit maximization only covers short term income. However, profit
maximization is also important because this needs to have higher profits to archive
growth objectives but it more important to increase shareholder’s wealth.

2. The risk in an investment refers to the expectation of suffering loss from an
investment. Risk free investments are those investments which do not involve any
risk. These risk free investments mostly comprise government securities like treasury
bills, governmental bonds or certificates of deposits. These investments neither
involve risk nor involve higher return as another risk investment involves.
Risk aversion is a position of an inventor in which investor chooses less risky
investment between two investment with the similar return and different associated
risks. In risk aversion investor dislikes the risk but wants to take the higher return.
Risk aversion is a process in which corporate manager want to take the minimum risk
but not “no risk” (Cohn, Lewellen, Lease, & Schlarbaum, 1975).
Risk aversion implies that corporate managers do not want to take higher risk for the
similar return that can be earned for lower risk . It does not imply that corporate
manager wants to take no risk.
For example, If corporate manager having resources to make one investment and
available options are two. The first option involves return 20% and risk 10% another
investment involves return 20% and risk 20%. Then a risk aversion investor will
surely choose first investment which involves return 20% and risk 10% because under
this investment he will earn a similar return with lower risk.
Therefore, above discussion concludes that risk aversion is position in which
corporate manager like to move towards lower risk. It does not imply the position that
corporate manager will undertake only risk free investment. Risk aversion results in
investment in a lowest risky investment at any specific level of return. It does not
result in a non risky investment at any specific level of return.

Question 3
i) Monthly Holding period return
Stock price Monthly Holding period return
CBA RIO MKT CBA RIO MKT
01-Jan 85.44 44.63 5344
31-Jan 78.67 39.13 5056 -7.92% -12.32% -5.39%
29-Feb 70.14 40.28 4945 -10.84% 2.94% -2.20%
31-Mar 74.92 42.69 5151 6.81% 5.98% 4.17%
30-Apr 73.89 51.55 5316 -1.37% 20.75% 3.20%
31-May 77.43 44.69 5469 4.79% -13.31% 2.88%
30-Jun 74.37 45.5 5192 -3.95% 1.81% -5.06%
31-Jul 77.35 49.56 5644 4.01% 8.92% 8.71%
31-Aug 71.81 47.6 5607 -7.16% -3.95% -0.66%
30-Sep 72.4 51.61 5525 0.82% 8.42% -1.46%
31-Oct 73.39 54.18 5370 1.37% 4.98% -2.81%
30-Nov 78.65 57.75 5570 7.17% 6.59% 3.72%
31-Dec 82.41 59.9 5719 4.78% 3.72% 2.68%
Data source
CBA: (Commonwealth Bank of Australia: ASX:CBA quotes & news - Google Finance, 2017)
RIO: (Rio Tinto Limited: ASX:RIO historical prices - Google Finance, 2017)
MKT: (All Ordinaries - Shares Prices & Charts, 2017)
Average monthly holding period return
Monthly Holding period return
CBA RIO MKT
01-Jan
31-Jan -7.92% -12.32% -5.39%

29-Feb -10.84% 2.94% -2.20%
31-Mar 6.81% 5.98% 4.17%
30-Apr -1.37% 20.75% 3.20%
31-May 4.79% -13.31% 2.88%
30-Jun -3.95% 1.81% -5.06%
31-Jul 4.01% 8.92% 8.71%
31-Aug -7.16% -3.95% -0.66%
30-Sep 0.82% 8.42% -1.46%
31-Oct 1.37% 4.98% -2.81%
30-Nov 7.17% 6.59% 3.72%
31-Dec 4.78% 3.72% 2.68%
Total -1.51% 34.54% 7.78%
Average holding period return -0.13% 2.88% 0.65%
ii) Annual holding period return
Stock price
CBA RIO MKT
01-Jan 85.44 44.63 5344
31-Dec 82.41 59.9 5719
Annual Holding period return -3.55% 34.21% 7.02%
iii) Standard deviation
Monthly return Square of deviation
CBA RIO MKT CBA RIO MKT
31-Jan -7.92% -12.32% -5.39% 0.006074 0.023115 0.003647
29-Feb -10.84% 2.94% -2.20% 0.011476 3.47E-07 0.00081
31-Mar 6.81% 5.98% 4.17% 0.004823 0.000963 0.001236
30-Apr -1.37% 20.75% 3.20% 0.000155 0.031949 0.000652

31-May 4.79% -13.31% 2.88% 0.002422 0.026203 0.000496
30-Jun -3.95% 1.81% -5.06% 0.001461 0.000114 0.003266
31-Jul 4.01% 8.92% 8.71% 0.001711 0.003652 0.006489
31-Aug -7.16% -3.95% -0.66% 0.004945 0.004671 0.00017
30-Sep 0.82% 8.42% -1.46% 9.06E-05 0.003074 0.000446
31-Oct 1.37% 4.98% -2.81% 0.000224 0.000441 0.001194
30-Nov 7.17% 6.59% 3.72% 0.005325 0.001376 0.000945
31-Dec 4.78% 3.72% 2.68% 0.002411 7.11E-05 0.00041
Total -1.51% 34.54% 7.78% 0.041119 0.095629 0.019763
Average return -0.13% 2.88% 0.65%
Standard deviation 6.11% 9.32% 4.24%
iv) Required graph
Return Standard deviation
CBA -0.13% 6.11%
RIO 2.88% 9.32%
MKT 0.65% 4.24%

3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00%
-0.50%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
Plotting of risk and return
RIsk
R
e
t
u
r
n
MKT
CBA
RIO
v) Calculation of expected return
CBA RIO
Risk free rate of return 3.25% 3.25%
Market rate of return 7% 7%
Beta of stock 1.11 0.95
Expected return 7.41% 6.81%
Expected return
= Risk free rate of return+ (Market rate of return- Risk free rate of return)* Beta of stock
vi) Security market line graph

0 0.2 0.4 0.6 0.8 1 1.2
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00% Security market line
Securi
ty
marke
t line
Beta
E
x
p
e
c
t
e
d
R
e
t
u
r
n
vii) Portfolio of CBA and RIO
Expected return of portfolio = 7.41%*60%+6.81%*40% = 7.17%
Beta of portfolio = 1.11*60%+0.95*40% = 1.046
viii) Data for making decision
CBA RIO Portfolio
Beta 1.11 0.95 1.046
Expected return 7.41% 6.81% 7.17%
As per capital asset pricing model, beta of the stock is systematic risk of stock and shows
volatility of stock or portfolio. Expected return under stock CBA is highest hence it is advised to
choose stock CBA.

References
All Ordinaries - Shares Prices & Charts. (2017). Retrieved August 28, 2017, from
http://www.marketindex.com.au: http://www.marketindex.com.au/all-ordinaries
Auerbach, A. (1979). Wealth maximization and the cost of capital. The Quarterly Journal of
Economics , 93 (3), 433-446.
Cohn, R., Lewellen, W., Lease, R., & Schlarbaum, G. (1975). Individual investor risk aversion
and investment portfolio composition. The Journal of Finance , 30 (2), 605-620.
Commonwealth Bank of Australia: ASX:CBA quotes & news - Google Finance. (2017).
Retrieved August 2017, 28, from https://www.google.com: https://www.google.com/finance?
q=ASX%3ACBA&ei=tFiiWejuMcejugTW54WoCg
Rio Tinto Limited: ASX:RIO historical prices - Google Finance. (2017). Retrieved august 28,
2017, from https://www.google.com/finance: https://www.google.com/finance/historical?