1. Here are data on two companies. The T-bill rate is 4% and the market risk pre
ID: 1170640 • Letter: 1
Question
1. Here are data on two companies. The T-bill rate is 4% and the market risk premium is 6%.
Company
$1 Discount Store
Everything $5
Forecast return
12%
11%
Standard deviation of returns
8%
10%
Beta
1.5
1.0
What would be the fair return for each company, according to the capital asset pricing model (CAPM)? (LO 7-1)
2. What must be the beta of a portfolio with E ( rP ) = 20%, if r f = 5% and E ( rM ) = 15%? (LO 7-2)
3. The market price of a security is $40. Its expected rate of return is 13%. The risk-free rate is 7%, and the market risk premium is 8%. What will the market price of the security be if its beta doubles (and all other variables remain unchanged)? Assume the stock is expected to pay a constant dividend in perpetuity. (LO 7-2)
4. Consider the following table, which gives a security analyst’s expected return on two stocks for two particular market returns: (LO 7-2)
Market Return
Aggressive Stock
Defensive Stock
5%
2%
3.5%
20
32
14
a. What are the betas of the two stocks?
b. What is the expected rate of return on each stock if the market return is equally likely to be 5% or 20%?
c. If the T-bill rate is 8%, and the market return is equally likely to be 5% or 20%, draw the SML for this economy.
d. Plot the two securities on the SML graph. What are the alphas of each?
e. What hurdle rate should be used by the management of the aggressive firm for a project with the risk characteristics of the defensive firm’s stock?
If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.
5.
Portfolio
Expected Return
Beta
A
20%
1.4
B
25
1.2
6.
Portfolio
Expected Return
Standard Deviation
A
30%
35%
B
40
25
7
Portfolio
Expected Return
Standard Deviation
Risk free
10%
0%
Market
18
24
A
16
12
8
Portfolio
Expected Return
Standard Deviation
Risk free
10%
0%
Market
18
24
A
20
22
9
Portfolio
Expected Return
Beta
Risk free
10%
0
Market
18
1.0
A
16
1.5
10
Portfolio
Expected Return
Beta
Risk free
10%
0
Market
18
1.0
A
16
.9
11.
Portfolio
Expected Return
Standard Deviation
Risk free
10%
0%
Market
18
24
A
16
22
12. A share of stock is now selling for $100. It will pay a dividend of $9 per share at the end
of the year. Its beta is 1. Assume the risk free rate is 8% and the expected rate of return on the market is 18%. What do investors expect the stock to sell for at the end of the year?
Company
$1 Discount Store
Everything $5
Forecast return
12%
11%
Standard deviation of returns
8%
10%
Beta
1.5
1.0
Explanation / Answer
1.
What would be the fair return for $1 Discount Store, according to the capital asset pricing model
=risk free rate+Beta*market risk premium
=4%+1.5%*6%
=13.00%
What would be the fair return for Everything $5, according to the capital asset pricing model
=risk free rate+Beta*market risk premium
=4%+1.0%*6%
=10.00%
the above is answer..
we do only one question based on Chegg rule
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