Problem 10. Suppose you observe the following situation Security Abel Co. Baker

Question

Problem 10. Suppose you observe the following situation Security Abel Co. Baker Co. Beta Expected Return 2.4 16.4% 0.8 8.6% Assume these securities are correctly priced according to SMI What is the.sspested Problem 11. The McCabe Mutisal Fund has invested its portfolio according to the following data What is a Beta of this Fund? (5 points) Stock Beta 2.8 1.0 Investment UAL IBM Home shop $150 million $100 milliorn S 50 million $200 million Geico 0.6 Problem 12. Investors expect the risk-free rate this year to be 3 percent. A stock with a beta of 1.5 has an expected rate of return of 15 percent If the risk-free rate this year turns out to be 5 percent, what will be the rate of return on this stock? (6 points) If the risk-free rate is 4% and the 9%, is a security with a beta of 1.8 and an expected return of 1 5% overpriced or underpriced? (6 points) expected rate of return on the market portfolio is Problem 13. Page 8 of 8

Explanation / Answer

(10) Let the Risk-Free Rate be A and the Expected Return on the Market be B. Assuming that CAPM is true, the following relationships would hold:

For Abel Co: 16.4 = A + 2.4 x (B-A) - (i) and For Baker Co. 8.6 = A + 0.8 x (B-A) - (ii)

Subtracting (ii) from (i), we get:

B-A = 4.875 which implies A = 16.4 - 2.4 x 4.875 = 4.7 %

B = 4.875 + 4.7 = 9.575 %

Hence, the expected return on the market is 9.575 % per annum

NOTE: Please raise separate queries for solutions to the remaining unrelated questions.

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