Question 1

Thayer Farms stock has a beta of 1.12.The risk-free rate of return is 4.34 percent and the market risk premium is 7.92 percent.What is the expected rate of return on this stock?

Accepted Answer

E(r) = 0.0434 + (1.12 × 0.0792) = 13.21 percent

Question 2

What is the expected return and standard deviation for the following stock?

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Question 3

Explain the difference between systematic and unsystematic risk.Also explain why one of these types of risks is rewarded with a risk premium while the other type is not.

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Question 4

Consider the following information on Stocks I and II:  The market risk premium is 8 percent, and the risk-free rate is 3.6 percent.The beta of stock I is _____ and the beta of stock II is _____.

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Question 5

Explain how the slope of the security market line is determined and why every stock that is correctly priced, according to CAPM, will lie on this line.

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Question 6

You have $10,000 to invest in a stock portfolio.Your choices are Stock X with an expected return of 13 percent and Stock Y with an expected return of 8 percent.Your goal is to create a portfolio with an expected return of 12.4 percent.All money must be invested.How much will you invest in stock X?

Accepted Answer

E(R_p) = 0.124 = .13x + .08(1 - x); x = 88 percentInvestment in Stock X = 0.88($10,000) = $8,800

Question 7

A stock has an expected return of 11 percent, the risk-free rate is 5.2 percent, and the market risk premium is 5 percent.What is the stock's beta?

Accepted Answer

E(R_i) = 0.11 = 0.052 + β_i(0.04); β_i = 1.16

Question 8

Suppose you observe the following situation:  Assume the capital asset pricing model holds and stock A's beta is greater than stock B's beta by 0.21.What is the expected market risk premium?

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Question 9

What is the expected return of an equally weighted portfolio comprised of the following three stocks?

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Question 10

The expected return on JK stock is 15.78 percent while the expected return on the market is 11.34 percent.The stock's beta is 1.51.What is the risk-free rate of return?

Accepted Answer

E(r) = 0.1578 = r_f + 1.51 (0.1134 - r_f); r_f = 2.63 percent

Question 11

You own a portfolio equally invested in a risk-free asset and two stocks.One of the stocks has a beta of 1.9 and the total portfolio is equally as risky as the market.What is the beta of the second stock?

Accepted Answer

β_p = 1.0 = (1/3)(0) + (1/3)(βx) + (1/3)(1.9); βx = 1.1

Question 12

A portfolio beta is a weighted average of the betas of the individual securities which comprise the portfolio.However, the standard deviation is not a weighted average of the standard deviations of the individual securities which comprise the portfolio.Explain why this difference exists.

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Question 13

The common stock of United Industries has a beta of 1.34 and an expected return of 14.29 percent.The risk-free rate of return is 3.7 percent.What is the expected market risk premium?

Accepted Answer

E(r) = 0.1429 = 0.037 + 1.34 M_rp; M_rp = 7.90 percent

Question 14

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.2 percent and the market rate of return is 11.76 percent?

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Question 15

A stock has a beta of 1.2 and an expected return of 17 percent.A risk-free asset currently earns 5.1 percent.The beta of a portfolio comprised of these two assets is 0.85.What percentage of the portfolio is invested in the stock?

Accepted Answer

β_p = 0.85 = 1.2x + (1 - x)(0); B_p = 71 percent

Question 16

Suppose you observe the following situation:  Assume these securities are correctly priced.Based on the CAPM, what is the return on the market?

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Question 17

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.7 percent and the market risk premium is 8.8 percent?

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Question 18

The common stock of Alpha Manufacturers has a beta of 1.14 and an actual expected return of 15.26 percent.The risk-free rate of return is 4.3 percent and the market rate of return is 12.01 percent.Which one of the following statements is true given this information?

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Question 19

Explain how the beta of a portfolio can equal the market beta if 50 percent of the portfolio is invested in a security that has twice the amount of systematic risk as an average risky security.

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Question 20

According to CAPM, the expected return on a risky asset depends on three components.Describe each component and explain its role in determining expected return.

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Quiz 13: Cost of Capital