1. You have estimated the following probability distributions of expected future
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Question
1. You have estimated the following probability distributions of expected future returns fo stocks A and B Stock A Stock B Probability Probability Return -10% 10% 15% 20% 40% Return 0.1 0.2 0.4 0.2 0.1 0.2 0.2 0.3 0.2 0.1 2% 7% 12% 15% 165 a. What is the expected return of stock A?(25 points) b. What is the expected return of stock B? (25 points) 2. Given a risk-free rate (Rf) of 6 percent and a market risk premium (Rm-Rf) of 8 percent, calculate the required rate of return on each of the following stocks: a. American Electric Power (beta 0.65) b. Citigroup (beta 2.05) c. General Mills (beta 0.50) d. Wynn Resorts (beta 1.80) e. JPMorgan Chase (beta 1.25)Explanation / Answer
1a. Stock A Probability (A) Return(B) A*B 0.1 -10% -0.01 0.2 10% 0.02 0.4 15% 0.06 0.2 20% 0.04 0.1 40% 0.04 0.15 Expected Return of Stock A is 15% b. Stock b Probability (A) Return(B) A*B 0.2 2% 0.004 0.2 7% 0.014 0.3 12% 0.036 0.2 15% 0.030 0.1 16% 0.016 0.100 Expected Return of Stock A is 10% 2.. Required Rate of Return = Risk Free Rate + Beta * Market Risk Premium a. American Electric Power Required Rate of Return = 0.06 + 0.65 * 0.08 = 0.112 or 11.2% b, Citigroup Required Rate of Return = 0.06 + 2.05 * 0.08 = 0.224 or 22.4% c. General Mills Required Rate of Return = 0.06 + 0.5 * 0.08 = 0.100 or 10.0% d. Wynn Resorts Required Rate of Return = 0.06 + 1.8 * 0.08 = 0.204 or 20.4% e. JPMorgan Chase Required Rate of Return = 0.06 + 1.25 * 0.08 = 0.160 or 16.0%
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