Question 1

If the required return on a stock is 15% and the future price of the stock one year from today is projected to be $32.00, what should be the current price for the stock assuming no dividends are paid?

Accepted Answer

The current price of the stock can be calculated using the formula for the present value of a future cash flow: Present Value = Future Value / (1 + required return). Plugging in the given values: Present Value = $32.00 / (1 + 0.15) = $32.00 / 1.15 = $27.83.

Question 2

Use the following information to calculate your company's expected return.

Accepted Answer

The question does not provide any specific information about the expected return, so we cannot make any calculations or assumptions. Therefore, we should choose the closest option to the average expected return of the stock market, which is around 10-12%. Among the choices provided, Option B with a 13% expected return seems to be the most reasonable and closest to the average.

Question 3

In general, which of the securities below has the highest expected return on investment?

Accepted Answer

Common stock typically has the highest expected return on investment because it represents ownership in a company and has the potential for capital appreciation and dividends. U.S government bonds and preferred stock generally have lower returns, while corporate bonds offer moderate returns with higher risk.

Question 4

If a firm receives bad news about its future earnings prospects, what should happen to the stock price in order to maintain the required return desired by new investors?

Accepted Answer

If there is bad news about a firm's future earnings prospects, investors will likely perceive the firm as having higher risk and lower potential for growth. This will result in a decrease in demand for the stock, causing the stock price to decrease in order to maintain the required return desired by new investors.

Question 5

Elephant Company common stock has a beta of 1.2. The risk-free rate is 6 percent and the expected market rate of return is 12 percent. Determine the required rate of return on the security.

Accepted Answer

The required rate of return on the security can be calculated using the Capital Asset Pricing Model (CAPM) formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the values: Required Return = 6% + 1.2 * (12% - 6%) = 6% + 1.2 * 6% = 6% + 7.2% = 13.2%.

Question 6

The expected rate of return for 3COM is 18 percent, with a standard deviation of 10.98 percent. The expected rate of return for Just the Fax is 26 percent with a standard deviation of 15.86%. Which firm would be considered the riskier from a total risk perspective?

Accepted Answer

The answer of The expected rate of return for 3COM...

Question 7

Kelvin Inc. has required return of 15% and a beta of 2. If the risk-free rate is 3%, calculate the slope of the SML.

Accepted Answer

The slope of the Security Market Line (SML) is calculated using the formula for the Capital Asset Pricing Model (CAPM), which is: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). The slope is represented by the term Beta * (Market Return - Risk-Free Rate), which is the difference between the expected return and the risk-free rate, divided by the beta. Given that Kelvin Inc. has a required return of 15%, a beta of 2, and the risk-free rate is 3%, we can rearrange the CAPM formula to solve for the market return: 15% = 3% + 2 * (Market Return - 3%). Solving for the slope directly, we use the given information: the required return minus the risk-free rate, divided by the beta, which gives us (15% - 3%) / 2 = 12% / 2 = 6%. Therefore, the slope of the SML is 6.0%.

Question 8

Ken Howard has a two stock portfolio consisting of Acton Inc. and Boron Corp. Assume the following conditions exist.  What does the SML predict is Ken's required rate of return for the overall portfolio?

Accepted Answer

The answer of Ken Howard has a two stock portfolio...

Question 9

If the required return for a stock is 14% annually, what should the stock price be one year from today assuming the current price is $24.00 and a dividend of $0.24 is paid sometime over the year?

Accepted Answer

Dividend for the year = $0.24
Required return = 14%
Dividend is paid sometime during the year, so we cannot use the dividend discount model directly. We can use the constant growth model, given as:
P = D / (r - g)

where P is the stock price, D is the expected dividend, r is the required return, and g is the expected growth rate.

We can estimate the expected growth rate using past growth rates or analyst estimates. Assuming a constant growth rate of 3%, we get:
P = $0.24 / (0.14 - 0.03)
P = $2.80

The stock price in one year should be the sum of the current price and the expected dividend and growth:
P = $24.00 + $2.80
P = $27.12

So the best choice is B.

Question 10

Security A will yield a 6% return in one year. Security B will either yield a 3% return or a 9% return in year with equal probability. Which is the better investment based on risk aversion and why?

Accepted Answer

When comparing investments, it is important to consider both the expected return and the level of risk involved. In this case, Security A has a guaranteed return of 6%, while Security B has an expected return of 6% (the average of 3% and 9%) with equal probability. However, Security B has a higher level of risk since there is a chance it may only yield 3%. Therefore, for someone who is risk averse, Security A would be the better investment choice because it has an equivalent expected return with less risk.

Question 11

Assume a portfolio is made up of four stocks:  The beta for the portfolio is:

Accepted Answer

The answer of Assume a portfolio is made up of...

Question 12

Use the following information to calculate the standard deviation of Macadam Corp.'s returns.

Accepted Answer

The answer of Use the following information to calculate the...

Question 13

Hatter Enterprise paid a dividend last year of $3.25, which is expected to grow at a constant rate of 7%. Hatter has a beta of 1.5 and their stock is currently selling for $62. If the market risk premium is 6% and the risk-free rate is 3%, should you purchase Hatter's stock?

Accepted Answer

The answer of Hatter Enterprise paid a dividend last year...

Question 14

Estimate the required return on Baniff Corp under the following conditions: The average stock is returning 11%
Short term treasury bills yield 5%
Baniff's beta is 1.25

Accepted Answer

The required return on Baniff Corp can be estimated using the Capital Asset Pricing Model (CAPM), which is given by the formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the given values: Required Return = 5% + 1.25 * (11% - 5%) = 5% + 1.25 * 6% = 5% + 7.5% = 12.5%.

Question 15

Frazier Manufacturing paid a dividend last year of $2, which is expected to grow at a constant rate of 5%. Frazier has a beta of 1.3. If the market is returning 11% and the risk-free rate is 4%, calculate the value of Frazier's stock.

Accepted Answer

The correct answer is A because the value of Frazier's stock is $25.93. This is calculated using the Gordon Growth Model, which is:```Stock Price = Dividend / (Required Rate of Return - Growth Rate)```In this case, the dividend is $2, the required rate of return is 11% (the market return plus the beta of 1.3 times the risk-free rate of 4%), and the growth rate is 5%. Plugging these values into the formula, we get:```Stock Price = $2 / (0.11 - 0.05) = $25.93```

Question 16

Use the following information to calculate Overland's expected return.

Accepted Answer

The answer of Use the following information to calculate Overland's...

Question 17

Charlie Dobbs is considering investing in Astrotech. His research has revealed the following: The market is returning 11%
Three month treasury bills are yielding 5%
Astrotech's beta is 1.2
Astrotech recently paid a dividend of $1.50
Analysts expect Astrotech to grow at 4% indefinitely
How much should Charlie be willing to pay for a share of Astrotech?

Accepted Answer

To determine the price Charlie should be willing to pay for a share of Astrotech, we can use the Gordon Growth Model (also known as the Dividend Discount Model for a perpetually growing dividend). The formula is P = D / (k - g), where P is the price, D is the dividend, k is the required rate of return, and g is the growth rate.First, we need to calculate the required rate of return (k) using the Capital Asset Pricing Model (CAPM), which is k = risk-free rate + beta * (market return - risk-free rate). Plugging in the values: k = 5% + 1.2 * (11% - 5%) = 5% + 1.2 * 6% = 5% + 7.2% = 12.2%.Next, we use the Gordon Growth Model with D = $1.50, k = 12.2%, and g = 4%: P = $1.50 / (12.2% - 4%) = $1.50 / 0.082 = $18.29.Therefore, Charlie should be willing to pay $18.29 for a share of Astrotech.

Question 18

You have invested in stocks W and X. From the following information, determine the beta for your portfolio.

Accepted Answer

The answer of You have invested in stocks W and...

Question 19

Compute the risk premium for the stock of Omega Tools if the risk-free rate is 6%, the expected market return is 12%, and Omega's stock has a beta of 0.8.

Accepted Answer

The formula for calculating the required rate of return using the capital asset pricing model (CAPM) is:

Required rate of return = risk-free rate + beta x (expected market return - risk-free rate)

Plugging in the given values:

Required rate of return = 6% + 0.8 x (12% - 6%)
Required rate of return = 6% + 0.8 x 6%
Required rate of return = 6% + 4.8%
Required rate of return = 10.8%

The risk premium is the difference between the required rate of return and the risk-free rate:

Risk premium = Required rate of return - Risk-free rate
Risk premium = 10.8% - 6%
Risk premium = 4.8%

Therefore, the answer is B.

Question 20

In general, which of the securities below has the most risk?

Accepted Answer

Common stock typically carries the most risk as its value can fluctuate greatly based on a company's performance and the overall market conditions. U.S. government bonds are considered to be the least risky as they are backed by the government, while corporate bonds and preferred stocks fall somewhere in between in terms of risk.

Quiz 9: Risk and Return