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Economy 101

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Youve observed the following returns on Crash-n-Burn Computers stock over the past five years: 11

percent, 11 percent, 18 percent, 23 percent, and 10 percent. Suppose the average inflation rate over

this period was 2.0 percent and the average T-bill rate over the period was 3.1 percent.

a.

What was the average real return on Crash-n-Burns stock? (Round your answer to 2 decimal places.

(e.g., 32.16))

Answer: 7.10

b.

What was the average nominal risk premium on Crash-n-Burns stock? (Round your answer to 1 decimal

place. (e.g., 32.1))

Answer: 8.0

2.Suppose you bought a 7 percent coupon bond one year ago for $860. The bond sells for $890 today.

a.

Assuming a $1,000 face value, what was your total dollar return on this investment over the past year?

Answer: 100

b.

What was your total nominal rate of return on this investment over the past year? (Round your answer

to 2 decimal places. (e.g., 32.16))

Answer: 11.63

c.

If the inflation rate last year was 1.5 percent, what was your total real rate of return on this investment?

(Round your answer to 2 decimal places. (e.g., 32.16))

Real rate of return %

Answer: 9.98

3.

Returns

Year X Y

1 13 % 23 %

2 16 28

3 12 15

4 11 12

5 10 18

Using the returns shown above, calculate the arithmetic average returns, the variances, and the

standard deviations for X and Y. (Round your percent answers to 2 decimal places. (e.g., 32.16) and

variances to 5 decimal places. (e.g., 32.16161))

XY

Average returns % %

Variances

Standard deviations % %

Answer:

X Y

Average returns 8.00% 14.40%

Variances 0.94% 1.94%

Standard deviations 9.70% 13.92%

4.Suppose a stock had an initial price of $60 per share, paid a dividend of $0.60 per share during the

year, and had an ending share price of $72.

What was the dividend yield and the capital gains yield? (Round your answers to 2 decimal places. (e.g.,

32.16))

Dividend yield %

Capital gains yield %

Answer:

Capital gains yield % 20.00%

5.

Youve observed the following returns on Crash-n-Burn Computers stock over the past five years: 16

percent, 16 percent, 18 percent, 28 percent, and 10 percent.

a.

What was the arithmetic average return on Crash-n-Burns stock over this five-year period? (Round your

answer to 1 decimal place. (e.g., 32.1))

Average return %

Answer: 11.2

b-1

What was the variance of Crash-n-Burns returns over this period? (Round your answer to 5 decimal

places. (e.g., 32.16161))

Variance

Answer: 0.02186

b-2

What was the standard deviation of Crash-n-Burns returns over this period? (Do not round

intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Standard deviation %

Answer: 14.78

6. Suppose a stock had an initial price of $62 per share, paid a dividend of $2.50 per share during the

year, and had an ending share price of $72.

Compute the percentage total return. (Round your answer to 2 decimal places. (e.g., 32.16))

Total return %

Answer: 20.16

7.Stock Y has a beta of 1.4 and an expected return of 16.5 percent. Stock Z has a beta of 0.7 and an

expected return of 9.8 percent. If the risk-free rate is 5.9 percent and the market risk premium is 6.9

percent, the reward-to-risk ratios for stocks Y and Z are and percent, respectively. Since the SML reward-

to-risk is percent, Stock Y is and Stock Z is(undervalued or overvalued?) . (Round your answers to 2

decimal places. (e.g., 32.16))

Answer: the reward-to-risk ratios for stocks Y and Z are 7.57 and 5.57 percent, respectively. Since the

SML reward-to-risk is 6.90 percent, Stock Y is undervalued and Stock Z is overvalued

8. A stock has an expected return of 18 percent, its beta is 1.45, and the risk-free rate is 4 percent. What

must the expected return on the market be? (Round your answer to 2 decimal places. (e.g., 32.16))

Answer: 13.66

9. A stock has a beta of 1.14, the expected return on the market is 10 percent, and the risk-free rate is

3.5 percent. What must the expected return on this stock be? (Round your answer to 2 decimal places.

(e.g., 32.16))

Expected return %

Answer: 10.91

10.

Consider the following information:

State of Probability of

Economy State of Economy Stock A Stock B

Recession 0.21 0.06 0.21

Normal 0.58 0.09 0.08

Boom 0.21 0.14 0.25

Calculate the expected return for the two stocks. (Round your answers to 2 decimal places. (e.g., 32.16))

Expected return

Stock A %

Stock B %

Answer: stock A = 9.42

Stock B = 5.48%

Calculate the standard deviation for the two stocks. (Do not round intermediate calculations and round

your final answers to 2 decimal places. (e.g., 32.16))

Standard deviation

Stock A %

Stock B %

Stock B = 15.20

State of Economy Portfolio Return

if State Occurs

Recession 0.17 0.13

Normal 0.53 0.14

Boom 0.30 0.22

Calculate the expected return. (Round your answer to 2 decimal places. (e.g., 32.16))

Expected return %

Answer: 11.81

12.

What are the portfolio weights for a portfolio that has 140 shares of Stock A that sell for $50 per share

and 120 shares of Stock B that sell for $40 per share? (Round your answers to 4 decimal places. (e.g.,

32.1616))

Portfolio weights

Stock A

Stock B

Answer:

Stock A = 0.5932

Stock B = 0.4068

13.

A stock has an expected return of 13.4 percent, the risk-free rate is 9 percent, and the market risk

premium is 10 percent. What must the beta of this stock be? (Round your answer to 2 decimal places.

(e.g., 32.16))

Beta of stock

Answer: 0.44

14.

You own a stock portfolio invested 40 percent in Stock Q, 25 percent in Stock R, 20 percent in Stock S,

and 15 percent in Stock T. The betas for these four stocks are 0.93, 1.10, 1.10, and 1.28, respectively.

What is the portfolio beta? (Round your answer to 2 decimal places. (e.g., 32.16))

Portfolio beta

Answer: 1.06

15.You own a portfolio that has $2,500 invested in Stock A and $3,500 invested in Stock B. If the

expected returns on these stocks are 10 percent and 13 percent, respectively, what is the expected

return on the portfolio? (Round your answer to 2 decimal places. (e.g., 32.16))

Answer: 11.75

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