MID-ATLANTIC SPECIALTY, INC.
Financial Risk
1. Compare the stand-alone risk/expected return of each of the four investments and the S&P 500 listed in
exhibit 12.1.
2. MSI is considering two investment strategies:
– 50 percent in Healthcare Fund and 50 percent in Inverse ETF
– 50 percent in Healthcare Fund and 50 percent in Biotech Fund
Compare the risk of the two portfolios. Why does the risk differ?
3. a. Use the historical returns in exhibit 12.2 to create a graph with market characteristic lines for a 1-
year T-Bill, Healthcare Fund, Inverse ETF, and Biotech Fund. Compare the market risk of each of
the four investments.
b. What would happen to the overall risk of a well-diversified portfolio with an investment in a 1-Year
T-Bill? Healthcare Fund? Inverse ETF? Biotech Fund?
c. What does the distance between the market characteristics line and the expected return of an
investment indicate?
4. a. Construct a Security Market Line graph and plot the expected return of each investment on the
graph.
b. If you were an individual investor with a well-diversified portfolio, which investment(s) in exhibit 12.1
would you buy? Why?
c. What does the distance between the Security Market Line and the expected return of an investment
indicate?
5. a. Is the return on the one-year T-bill risk free?
b. Suppose MSI wants to construct a portfolio of stocks that has an expected return equal to the riskfree rate. Is such a portfolio possible? Is such a portfolio likely?
c. Suppose that you choose to hold a single stock investment in isolation. Would you be compensated
for all of the risk that you assume? Explain.
6. In your opinion, what are three key learning points from this case?