Case Study 13 Instructions Southeastern Specialty, Inc.: Financial Risk There is no spreadsheet for this case. Answer ONLY the questions here, NOT the questions in the casebook, even though many are similar. Do not get worried about Question 9 in the casebook; will not cover efficient markets in this course.

Here is some basic calculated data to use in the questions below, derived from Exhibit 13.1:

Investment Expected Return (Mean) SD CV | | T-Bill 7.0% 0.0% 0.00 | Project A 13.5% 11.7% 0.87 | Project B 8.8% 9.1% 1.03 | S&P 500 15.0% 16.4% 1.10 | SSI 10.0% 5.5% 0.55 |

SD = Standard Deviation
CV = Coefficient of Variation

Please answer the questions below:

1. Is the return on the T-Bill risk-free? Under what real-world conditions might there be some risk associated with T-Bills?

2. Solely on the basis of expected return, which potential investment is best?
Answer

Based on the expected returns, the potential investment that appears the best is 15% with S & P 500 Fund.

(Probability of Return 1 x Return 1) + (Probability of Return 2 x Rate 2) = Expected Rate of Return

1-Year T-Bill
(0.10 x .07) + (0.20 x .07) + (0.40 x .07) + (0.20 x .07) + (0.10 x .07) = .07 = 7%

Project A
(0.10 x [-.08]) + (0.20 x .02) + (0.40 x .14) + (0.20 x .25) + (0.10 x .33) = .135 = 13.5%

Project B
(0.10 x .18) + (0.20 x .23) + (0.40 x .07) + (0.20 x [-.03]) + (0.10 x .02) = .088 = 8.8%

S & P 500 Fund
(0.10 x [-.15]) + (0.20 x 0) + (0.40 x .15) + (0.20 x .30) + (0.10 x .45) = .15 = 15%

Equity in SSI
(0.10 x 0) + (0.20 x .05) + (0.40 x .10) + (0.20 x .15) + (0.10 x .20) = .10 = 10%

3. Based on the SD and CV:

a. What type of risk do these statistics measure? b. Is the SD or CV the better measure of this type of risk? c.