Stock Y has a beta of .90 and an expected return of 15.75 percent. Stock Z has a

Question

Stock Y has a beta of .90 and an expected return of 15.75 percent. Stock Z has a beta of .80 and an expected return of 8 percent. If the risk-free rate is 6.0 percent and the market risk premium is 9.6 percent, what are the reward-to-risk ratios of Y and Z? (Do not round intermediate calculations. Round your answers to 4 decimal places.) 1) X=?? and Y= ??

2)

A share of stock sells for $46 today. The beta of the stock is 1.1, and the expected return on the market is 14 percent. The stock is expected to pay a dividend of $.90 in one year. If the risk-free rate is 4.5 percent, what should the share price be in one year?

3) You own a stock portfolio invested 15 percent in Stock Q, 33 percent in Stock R, 40 percent in Stock S, and 12 percent in Stock T. The betas for these four stocks are 1.4, .5, 1.5, and .8, respectively. What is the portfolio beta?

Stock Y has a beta of .90 and an expected return of 15.75 percent. Stock Z has a beta of .80 and an expected return of 8 percent. If the risk-free rate is 6.0 percent and the market risk premium is 9.6 percent, what are the reward-to-risk ratios of Y and Z? (Do not round intermediate calculations. Round your answers to 4 decimal places.) 1) X=?? and Y= ??

2)

A share of stock sells for $46 today. The beta of the stock is 1.1, and the expected return on the market is 14 percent. The stock is expected to pay a dividend of $.90 in one year. If the risk-free rate is 4.5 percent, what should the share price be in one year?

3) You own a stock portfolio invested 15 percent in Stock Q, 33 percent in Stock R, 40 percent in Stock S, and 12 percent in Stock T. The betas for these four stocks are 1.4, .5, 1.5, and .8, respectively. What is the portfolio beta?

Explanation / Answer

1) Using CAPM,

Required return on Stock Y = Risk free Rate + BetaY * Market Premium

                                            = 6 + 0.9 * 9.6 = 14.64%

Expected Return on Y = 15.75%

Since expected return > required return, the stock is undervalued.

Reward to risk Ratio = (expected return - risk free rate)/beta

For Y, Reward to risk Ratio = (0.1575 - 0.06)/0.9 = 0.1083

Required return on Stock Z = Risk free Rate + BetaZ * Market Premium

                                            = 6 + 0.8 * 9.6 = 13.68%

Expected Return on Z = 8%

Since expected return < required return, the stock is overvalued.

Reward to risk Ratio = (expected return - risk free rate)/beta

For Z, Reward to risk Ratio = (0.08 - 0.06)/0.8 = 0.025

2) Using CAPM,

Required rate of return = 4.5 + 1.1 * (14 - 4.5) = 14.95%

Using Dividend Discount Model

46 = (D1 + P1)/(1 + r) = (0.9 + P1)/(1 + 14.95%)

52.877 = 0.9 + P1

P1 = 51.977

Share Price in one year should be $51.977

3)

Porfolio Beta = Weighted Average of the Betas of the 4 stocks

                      =15% * 1.4 + 33% * 0.5 + 40% * 1.5 + 12% * 0.8 = 1.071

Stock Weight Beta Q 15% 1.4 R 33% 0.5 S 40% 1.5 T 12% 0.8

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