Suppose the expected return on the total market is 11%. A certain stock is price

Question

Suppose the expected return on the total market is 11%. A certain stock is priced such that its expected return is 10.1%. If the risk-free rate of return is 3.5%, what must be the beta of this stock?

1.35

Stock Q has an expected return of 13.5%. Its beta is 1.25. Given a risk-free rate of 6%, what is the reward-to-risk ratio for Stock Q, according to the CAPM?

0.06

Your company is considering two potential new investments: Project B and Project C. Each is a four-year project. The forecast cash flows for each project are shown below. The projects are independent.

You have analyzed the systematic risk of each project. Your analysis has determined that the beta for Project B is 0.55, and the beta for Project C is 1.75. The risk-free rate is 5.5% and the market risk premium is 6%. Which project or projects should be accepted?

Explanation / Answer

1.

Beta of stock is calculated below using CAPM model

Beta = (10.10% - 3.50%) / 11%

= 6.60% / 11%

= 0.60.

Beta of stock is 0.60.

Option (D) is correct answer.

2.

reward-to-risk ratio = (13.50% - 6.00%) / 1.25

= 7.50% / 1.25%

= 6%

reward-to-risk ratio is 6% or 0.06.

Option (E) is correct answer.

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