Alex Sharpe's Portfolio Solution Essay

1236 Words Sep 12th, 2013 5 Pages
Context:
Alex Sharpe currently invests her children’s educational savings in Vanguard 500 Index Fund, which tracks the performance of S&P 500 and is passively managed. However, she is now considering switching her investment strategy to a more active one to achieve better outcomes. Hasbro, a toy manufacturer, and Reynolds, a tobacco firm, have come into Sharpe’s sight and she wants to choose one of them and invest a small proportion of equity funds in it.
In order to select a more appropriate investment target, the following issues should be taken into consideration by Sharpe: 1) What are the risk-return characteristics of each stock 2) What are the impacts of either stock to the overall risk-return profiles of the equity
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In fact, it is another evidence of the low correlation between Reynolds’s returns and index’s returns. On the other hand, Hasbro’s R-square is 0.397, which indicates a much more explanatory power from using this model. Correspondingly, the regression plots show that Hasbro’s returns tend to be more concentrated around the line whereas Reynolds’s returns are more separated from the line.
This is consistent with the description of the case. Actually, Hasbro is operating in entertainment industry, which is generally sensitive to performance of the economy as a whole. For instance, when economy is good, people will have more income to spend on Hasbro’s products, thus enhancing the firm’s return. In contrast, Reynolds is a tobacco company, which can be considered having an inelasticity of demand (Tucker, I. 2012). Consequently, the fluctuations in the whole economy usually do not have much impact on the firm’s return. As a result of less sensitive to the common macro factor, Reynolds has a lower systematic risk (beta) than beta.
To the extent that Reynolds still has a large standard deviation despite of low beta, it is all due to the unsystematic component of risk (or we can say firm’s unique risks) that the firm is exposed to. In fact, Reynolds may face litigations related to health problem, which can severely damage the

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