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a. 10.80
b. 1.46
c. 15.72
d. 0.69
e. 4.22
vi
. T. Martell Inc.'s stock has a 50% chance of producing a 32.2% return, a
35% chance of producing a 9% return, and a 15% chance of producing a -
25% return. What is Martell's expected return?
a.
14.4%
b.
15.5%
c.
16.0%
d.
16.8%
e.
17.6%
vii
. Parr Paper's stock has a beta of 1.442, and its required return is 13.00%. Clover
Dairy's stock has a beta of 0.80. If the risk-free rate is 4.00%, what is the
required rate of return on Clover's stock? (Hint: First find the market risk
premium.)
a. 8.55%
b. 8.71%
c. 8.99%
d. 9.14%
e. 9.33%
viii
. Suppose you hold a diversified portfolio consisting of a $10,000 invested equally
in each of 10 different common stocks. The portfolios beta is 1.120. Now
suppose you decided to sell one of your stocks that has a beta of 1.000 and to
use the proceeds to buy a replacement stock with a beta of 2.260. What would
the portfolios new beta be?
a. 0.982
b. 1.017
c. 1.195
d. 1.246
e. 1.519
ix
. Assume the risk-free rate is 5% and that the market risk premium is 6.20%. If a
stock has a required rate of return of 12.75%, what is its beta?
a. 1.11
b. 1.25
c. 1.06
d. 1.60
e. 1.96
x
. An investor is forming a portfolio by investing $50,000 in stock A that has a beta
of 1.50, and $25,000 in stock B that has a beta of 0.90. The market risk premium
is equal to 2% and Treasury bonds have a yield of 4%. What is the required rate
of return on the investors portfolio?
a. 6.8%
b. 6.6%
c. 5.8%
d. 7.0%
e. 7.5%
xi
. Your portfolio consists of $100,000 invested in a stock that has a beta = 0.8,
$150,000 invested in a stock that has a beta = 1.2, and $50,000 invested in a
stock that has a beta = 1.8. The risk-free rate is 7%. Last year this portfolio had
a required return of 13%. This year nothing has changed except that the market
risk premium has increased by 2%. What is the portfolios current required rate of
return?
a. 5.14%
b. 7.14%
c. 11.45%
d. 15.33%
e. 16.25%
xii
. Which of the following statements is CORRECT? (Assume that the risk-free rate
is a constant.)
a. If the market risk premium increases by 1%, then the required return on all
stocks will rise by 1%.
b. If the market risk premium increases by 1%, then the required return will
increase for stocks that have a positive beta, but it will decrease for stocks
that have a negative beta.
c. If the market risk premium increases by 1%, then the required return will
increase by 1% for a stock that has a beta of 0.50.
d. The effect of a change in the market risk premium on the required rate of
return depends on the level of the risk-free rate.
e. The effect of a change in the market risk premium on the required rate of
return depends on the slope of the yield curve.
xiii
. Stock A and Stock B both have an expected return of 10% and a standard
deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of
1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P is a
portfolio with 50% invested in Stock A and 50% invested in Stock B. Which of the
following statements is CORRECT?
The standard deviation of the portfolio will be less than the weighted
average of the two stocks standard deviations because the correlation
coefficient is less than one. Therefore, although the expected return on the
portfolio will be the weighted average of the two returns (10 percent), the
CV will not be equal to 25%/10%. Therefore, statement a is false. Remember,
market risk is measured by beta. The beta of the portfolio will be the
weighted average of the two betas; therefore, it will be less than the beta
of the high-beta stock (B), but more than the beta of the low-beta stock (A).
Therefore, the market risk of the portfolio will be higher than As, but
lower than Bs. Therefore, statement b is correct. Because the correlation
between the two stocks is less than one, the portfolios standard deviation
will be less than 25 percent. Therefore, statement c is false.
Step 1: We must determine the market risk premium using the CAPM equation with data
inputs for Stock A:
kA = kRF + (kM kRF)bA
11%= 5% + (kM kRF)1.0
6% = (kM kRF).
Step 2: We can now find the required return of Stock B using the CAPM equation with data
inputs for Stock B:
kB = kRF + (kM kRF)bB
kB = 5% + (6%)1.4
kB = 13.4%.
Using your financial calculator you find the mean to be 10.8% and the
population standard deviation to be 15.715%. The coefficient of variation is
just the standard deviation divided by the mean, or 15.715%/10.8% = 1.4551
1.46.
1.00 15.50%
Number of stocks 10
Portfolio beta 1.120
Stock thats sold 1.000
Stock thats bought 2.260
12.75% = 5% + 6.2%(b)
7.75% = 6.2%(b)
b = 1.25.
The portfolios beta is a weighted average of the individual security betas as follows:
This year:
r = 7% +(5.1429% + 2%)1.1667
r = 15.33%.
The standard deviation of the portfolio will be less than the weighted average of the two
stocks standard deviations because the correlation coefficient is less than one. Therefore,
although the expected return on the portfolio will be the weighted average of the two returns
(10%), the CV will not be equal to 25%/10%. Therefore, statement a is false. Remember,
market risk is measured by beta. The beta of the portfolio will be the weighted average of the
two betas; therefore, it will be less than the beta of the high-beta stock (B), but more than the
beta of the low-beta stock (A). Therefore, the market risk of the portfolio will be higher than
As, but lower than Bs. Therefore, statement b is correct. Because the correlation between
the two stocks is less than one, the portfolios standard deviation will be less than 25%.
Therefore, statement c is false. Statements d and e are false, because Stock B has a higher
beta and consequently a higher required return, but the stocks have the same expected
returns.
From the CAPM equation: rs = rRF + (rM rRF)b, statement e is the only correct answer.