Question

FIN500

Week Three

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HomeworkAssignment

Work should be done individually.Word-process your solutions within this template and show all steps used in arriving at the final answers. Incomplete solutions will receive partial credit. Copy and paste all necessary data and create tables as needed.

1. The expected returns earned from investment in the stock of two companies, Company A and Company B, are shown in the following table. Use the table to complete parts (a) through (c) below.

Demand for Product

Probability of Demand

Expected Return: Stock A

Expected Return: Stock B

Strong

0.3

40%

20%

Normal

0.45

20%

5%

Weak

0.25

0%

(5%)

(a) Compute the expected rates of return for each stock.

(b) Compute the standard deviations for each stock.

(c) Compute the coefficient of variation for each stock. Based on the coefficient of variation, which stock has the higher risk for investment?

2. The expected returns earned from investment in the stock of two companies, Company A and Company B, are shown in the following table. Assume a two-stock portfolio with $25,000 in Company A and $75,000 in Company B. Compute the expected return on the portfolio.

Demand for Product

Probability of Demand

Expected Return: Stock A

Expected Return: Stock B

Strong

0.3

40%

20%

Normal

0.45

20%

5%

Weak

0.25

0%

(5%)

3. Suppose you have a portfolio consisting of three stocks. You invest a total of $200,000 in the stocks. The investments and beta for the stocks are shown in the following table. Use the table to complete parts (a) through (c) below.

Stock

Investment

Beta

1

$60,000

1.25

2

$40,000

(0.5)

3

$100,000

1.5

(a) Assume the risk-free rate is 5.5% and the expected return for the market is 10%. Estimate the appropriate required rate of return for each stock.

(b) Compute the portfolio beta.

(c) Find the portfolio’s required rate of return, assuming the same risk-free rate and expected return for the market as in part (a).

Problem 4

A stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return,

and a 25% chance of producing a -18% return. What is the stock’s expected rate of return?

Problem 5

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta

of 1.20. You are in the process of buying 1,000 shares of stock selling at $10 a share and adding

it to your portfolio. The newly purchased stock has an expected return of 13.0% and a beta of

1.50. The total value of your current portfolio is $90,000. What will the expected return and beta

on the portfolio be after the purchase of the new stock?

Problem 6

Calculate the required rate of return for a stock assuming that (1) investors expect a 4.0% rate of

inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4)

the stock has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5

years.

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