1)A stock has an expected return of 16.2 percent, a beta of 1.75, and the expect
ID: 2665014 • Letter: 1
Question
1)A stock has an expected return of 16.2 percent, a beta of 1.75, and the expected return on the market is 11% what must the risk-free rate be?
2) Base on the following information; calculate the expected return and standard deviation of each of the stocks. Assume each state of the economy is equally likely to happen. What are the covariance and correlation between the returns of the two stocks?
State of Economy Return on stock A Return on Stock B
Bear .082 -.065
Normal .095 .124
Bull .063 .185
Explanation / Answer
1.Expected Return Stock A = 7.9% Stock B = 8.1%
2.Standard deviation Stock A = 0 Stock B = 1.1%
Since standard deviation of stock A = 0 then covariance and correlation
coefficient between the returns of stock A and stock B are zero.
Standard Deviation
1
2
3
4
5
6
7
8
9
10
State of economy
probability
Stock A
Stock B
Expected Return
Expected Return
(Col 3 - 0.079)^2
(Col 4 -0.081)^2
Col 7 *Col 2
Col 8 * Col 2
Bear
0.33
0.082
-0.065
0.027
-0.021
0.000
0.021
0
0.007
Normal
0.33
0.095
0.124
0.031
0.041
0.000
0.002
0
0.001
Bull
0.33
0.063
0.185
0.021
0.061
0.000
0.011
0
0.004
Expected(R)
0.079
0.081
0
0.011
Standard Deviation
1
2
3
4
5
6
7
8
9
10
State of economy
probability
Stock A
Stock B
Expected Return
Expected Return
(Col 3 - 0.079)^2
(Col 4 -0.081)^2
Col 7 *Col 2
Col 8 * Col 2
Bear
0.33
0.082
-0.065
0.027
-0.021
0.000
0.021
0
0.007
Normal
0.33
0.095
0.124
0.031
0.041
0.000
0.002
0
0.001
Bull
0.33
0.063
0.185
0.021
0.061
0.000
0.011
0
0.004
Expected(R)
0.079
0.081
0
0.011
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