Assignment

Schumpeter Case

SF is planning to increase its allocation to equity and reduce its allocation to T-bills.
The increased allocation can be invested in the equity index, which historically has
been the firms strategy, or it can be invested in one of two individual stocks,
ThyssenKrupp or Deoleo. As a member of Schumpeters team, you are responsible
for estimating the risk for each of these three investments. Prepare a memo
describing how the team should measure and describe the risk of investments in the
three assets. Support your answer with logic and the facts from the case. The bullet
points below should help guide your analysis.

Measuring the risk of individual assets. To measure the risk of each of the three
investments (the STOXX Europe Total Market Index, or TMI; ThyssenKrupp stock;
and Deoleo stock), calculate the annualized standard deviation of the excess returns.
Excess return is the return on the asset minus the risk-free rate. Use the return on
German T-bills as the risk-free rate. Rank the assets risk from highest to lowest.

Firm risk. Describe the risks to which each stock (ThyssenKrupp and Deoleo) is
exposed. Consider whether these descriptions of risk are consistent with the
statistical measurement of risk from the prior calculation.

Measuring the risk of a portfolio. SF is going to reduce its allocation to T-bills by one
percentage point (from 35% to 34% of the portfolio). This 1% of the portfolio will
be allocated to either the STOXX Europe TMI, to ThyssenKrupp stock, or to Deoleo
stock. One percent less will be invested in T-bills. To measure the risk of each
hypothetical portfolio, calculate the annualized standard deviation of the excess
return on each portfolio. Rank the portfolios from highest to lowest risk. To
calculate the standard deviation of the excess returns, you first must calculate the
historical monthly returns on the three hypothetical portfolios (e.g., 34% T-bills,
65% equity index, and 1% Deoleo stock). Compare the standard deviation of excess
returns of the three hypothetical portfolios to the standard deviation of excess
returns if SF had maintained its 65% equity/35% T-bill allocation.

Measuring investors risk. Which of the two methods of measuring the risk should
SFs investors use? If your rankings using the above two methods are the same,
explain whether they will always be the same and if so, why. If your rankings using
the above two methods are not the same, explain why they differ and which method
is preferable. To answer this question, you should think about what kinds of risks
each stock faces (based on the company descriptions in the case and the list you
generated above) and the kinds of risk to which investors are exposed.