Liana, a financial analyst for HF Products, a home furnishing manufacturer, must evaluate the risk and return of two assets, X and Y. The firm is considering adding these assets to its diversified...

Liana, a financial analyst for HF Products, a home furnishing manufacturer, must evaluate the risk and return of two assets, X and Y. The firm is considering adding these assets to its diversified asset portfolio. To assess the return and risk of each asset, Liana gathered data on the annual cash flow and beginning- and end-of year values of each asset over the immediately preceding 10 years, 2011-2020. Junior's investigation suggests that both assets, on average, will tend to perform in the future just as they have during the past 10 years. She therefore believes that the expected annual return can be estimated by finding the average annual return for each asset over the past 10 years. Return Data for Assets X and Y, 2011-2020 Asset X Asset Y Value Value Year Beginning Ending Beginning Ending 2011 1.21 1.24 0.730 0.700 2012 1.27 1.21 0.750 0.730 2013 1.26 1.27 0.700 0.750 2014 1.22 1.24 0.680 0.710 2015 1.18 1.22 0.730 0.680 2016 1.08 1.18 0.745 0.730 2017 1.00 1.09 0.745 0.735 2018 0.97 1.00 0.730 0.745 2019 0.94 0.98 0.660 0.720 2020 0.88 0.94 0.720 0.660 Liana believes that each asset's risk can be assessed in two ways: in isolation and as part of the firm's diversified portfolio of assets. The risk of the assets in isolation can be found by using the standard deviation and coefficient of variation of returns over the past 10 years. The capital asset pricing model (CAPM) can be used to assess the asset's risk as part of the firm's portfolio of assets. Applying some sophisticated quantitative techniques, Liana estimated betas for assets X and Y of 1.20 and 0.60, respectively. In addition, she found that the riskfree rate is currently 3.30% and that the market return is 3.8%.
a. Calculate the annual rate of return for each asset in each of the 10 preceding years, and use those values to find the average annual return for each asset over the 10-year period. b. Use the returns calculated in part (a) to find (1) the standard deviation and (2) the coefficient of variation of the returns for each asset over the 10-year period 2011- 2020. c. Use your findings in parts (a) and (b) to evaluate and discuss the return and risk associated with each asset. Which asset appears to be preferable? Explain. d. Use the CAPM to find the required return for each asset. Compare this value with the average annual returns calculated in part (a). e. Compare and contrast your findings in parts (c) and (d). What recommendations would you give Liana with regard to investing in either of the two assets? Explain to Liana why she is better off using beta rather than the standard deviation and coefficient of variation to assess the risk of each asset. f. Rework parts (d) and (e) under each of the following circumstances: (i) A rise of 1% in inflationary expectations causes the risk-free rate to rise to 4.3% and the market return to rise to 4.8%. (ii) As a result of favorable political events, investors suddenly become less risk averse,causing the market return to drop by 0.5%, to 3.3%.