Q 3. The rates of return on Project A and or umon Project A A and the market por
ID: 2727540 • Letter: Q
Question
Q 3. The rates of return on Project A and or umon Project A A and the market portfolio in three future states are given below: State of Economy Probability Return on Return ón ProjectA- Market Portfolio Good Average Poor 33.3% 33.3% 33.3% 40% 20% -10% 30% 10% -10% . Calculate the expected return for Project A and for the market portfolio. Calculate the variance for the market portfolio. C Calculate the beta for Project A. d. If the risk free-rate is 5%, what is the required return for Project A? Should you invest in Project A?Explanation / Answer
a) Expected Return of A
.40*.3333+.20*.3333-10*.3333
=16.67%
Expected Return of market
.3*.3333+.1*.3333-10*.3333
=10%
b)
Variance of market
probability
return
variance
.33
.30
(.30-.10)2.3333
.0133.
.33
.10
(.10-.10)2.3333
0
.33
.-10
(-.10-.10)2.3333
.0133
.0266
c) covariance for beta
probability
return A
Return market
covariance
33.33
.40
.30
(.40-.1667)(.3-.1).3333
33.33
.20.
.10
(.20-.1667)(.1-.1).3333
33.33
-.10
.-10
(-.1-.1667)(-.1-.1).3333
.033
Beta of stock =covariance of market and stock/variance of market
.033/.0266=1.24
d)
CAPM return on A =.05+1.24(.10-.05)
=11.2%
probability
return
variance
.33
.30
(.30-.10)2.3333
.0133.
.33
.10
(.10-.10)2.3333
0
.33
.-10
(-.10-.10)2.3333
.0133
.0266
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