CASE DESCRIPTION:-

Mehman Sisters, your investment bank, is considering an investment. You have a little over $2,000,000 and you need to invest in the right place to ensure maximum returns in the smallest time frame while keeping your risk appetite in mind. Assess the profits and risks by answering the questions given below to reach the correct answer.

 

Option 1: REAL ESTATE

  • Primary Investment: $2,000,000
  • Annual Return Expected: 7%
  • Investment Duration: 5 years

Option 2: EQUITY

  • Primary investment: $1,500,000
  • Annual Return Expected: 12%
  • Investment Duration: 3 years

 

QUESTIONS:-

1. What is the projected ROI for each option?

2. What are the risks associated with each investment option?

3. Which investment option has better risk-adjusted returns?

4. Which investment option should the Mehman Sisters consider?
 

SOLUTION:-

1. Expected Return Calculation:-

Expected Return = Initial Investment × Annual Return × Investment Duration

  • Investment Option 1: ROI = $2,000,000 × 7% × 5 = $700,000
  • Investment Option 2: ROI = $1,500,000 × 12% × 3 = $540,000

2. Risk Calculation:-

To calculate risk, we will use the standard deviation of returns. Assuming a historical standard deviation of 10% for Real Estate and 15% for Equity:-

Risk = Initial Investment × Standard Deviation

  • Investment Option 1: Risk = $2,000,000 × 0.10 = $200,000
  • Investment Option 2: Risk = $1,500,000 × 0.15 = $225,000

3. Risk-Adjusted Return Calculation:-

Sharpe Ratio = (Expected Return - Risk-Free Rate) / Risk

  • Investment Option 1: Sharpe Ratio = ($700,000 - 3%) / $200,000 = 3.485
  • Investment Option 2: Sharpe Ratio = ($540,000 - 3%) / $225,000 = 2.386

(Assuming a risk-free rate of 3%)

4. Recommendation

Based on the calculation shown above, Investment Option 1 i.e. Real Estate has a higher expected return of $700,000 compared to Investment Option 2's $540,000. The Sharpe Ratio of Investment Option 2 (Stock Portfolio) is greater, indicating a better risk-adjusted return. Investment Option 2 is recommended for higher risk tolerance due to the risk-adjusted return.

 

CONCLUSION:-

In this case, the investment bank should pick Investment Option 2 (Stock Portfolio) since it provides a better risk-return balance, which is critical for long-term investment success.

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[Disclaimer: This case study is entirely hypothetical and unrelated to real-world situations. It's designed for educational purposes to illustrate theoretical concepts and potential scenarios within a given context. Any similarities to actual events or individuals are purely coincidental.]