Question

Question 3

Consider the following two investors’ portfolios consisting of
investments in four stocks:

Stock Beta Jack's Portfolio Nelson's Portfolio A 1.3 $2,500 $10,000
B 1.0 $2,500 $5,000 C 0.8 $2,500 $5,000 D -0.5 $2,500 $2,500
Portfolio Expected Return 10% 9%

(a)

Calculate the beta on portfolios of Jack and Nelson
respectively.

(b) Assuming that the risk-free rate is 4% and the
expected return on the market is 12%, determine the required return
on portfolios of Jack and Nelson respectively.

(c) From your answers in part (b), explain whether portfolios of
Jack and Nelson are over-priced, under-priced or correctly
priced.

(d) State and explain whether the following statement is true or
false: “If a security lies above the security market line (SML),
then it must be over-priced.” (word limit: 150 words)

Answer #1

A portfolio has the following composition:
Security
Weight
Expected Beta
A
10%
0.8
B
20%
1.1
C
30%
1.3
D
40%
0.7
What is the expected beta of the portfolio?
Stock A had a market value of $20, Stock B had a market value of
$30. During the year, Stock A generated cash flow of $3 and Stock B
generated cash flow of $4. The current market values are, Stock A
is $22 and Stock B is $31.
What is...

Consider a portfolio consisting of the following three
stocks:
Portfolio Weight
Volatility
Correlation with the Market Portfolio
HEC corporation
0.27
13%
0.37
Green Midget
0.39
29%
0.64
AliveAndWell
0.34
12%
0.53
The volatility of the market portfolio is 10% and it has an
expected return of 8%. The risk-free rate is 3%
a. Compute the beta and expected return of each stock.
(Round to two decimal places.)
b. Using your answer from part a, calculate the expected
return of the...

Consider the following expectations for the market and two
particular stocks in two possible equally likely states:
(Please show the work step by step)
State
Market
Return
Stock
A
Stock B
Boom
25% 38% 12%
Recession 5% -2%
6%
A. What is the beta of each stock? Remember that beta can be
computed as the covariance of the stock’s return with the market
return divided by the variance of the market return.
B. What is the expected return on each...

Assume investors hold the market portfolio. Rank the following
four securities based on their relative risk contributions to the
market portfolio, with the one that will contribute the least risk
first.
Security
Expected
return
Standard
deviation
Beta
A
13.2%
3.4%
0.8
B
18.6%
6.8%
1.4
C
15.0%
7.0%
1.0
D
14.1%
5.8%
0.9
A) A, D, C, B
B) A, D, B, C
C) D, A, B, C
D) C, B, A, D

Consider the following Table, which gives a security analyst’s
expected returns on two stocks and the market portfolio for two
possible economic states:
Market Portfolio, Aggressive Stock , Defensive Stock
State 1 3% 6% 9%
State 2 9% 24% 18%
a) What are the market betas of the two stocks?
b) What is the expected rate of return on each stock if the
economy is equally likely to be in the two economic states?
c) If the T-bill rate is...

Michael and Janine are both investors wanting to purchase
investment portfolios. The expected return, standard deviation and
beta of various investments are shown in the following table:
Investment
Average
return over last year (% pa)
Standard
Deviation (% pa)
Beta
Apocryphal Industries
16
11
1.8
Bona Fide Ltd
13
9
1.3
Market Index
11
2
1
10 year Bond
5
3
0
Michael wants a portfolio that has an expected return of 12% pa
and that contains only Apocryphal Industries...

Suppose Asset A has an expected return of 10% and a standard
deviation of 20%. Asset B has an expected return of 16% and a
standard deviation of 40%. If the correlation between A and B is
0.35, what are the expected return and standard deviation for a
portfolio consisting of 30% Asset A and 70% Asset B?
Plot the attainable portfolios for a correlation of 0.35. Now
plot the attainable portfolios for correlations of +1.0 and
−1.0.
Suppose a...

CAPM, portfolio risk, and return
Consider the following information for three stocks, Stocks A,
B, and C. The returns on the three stocks are positively
correlated, but they are not perfectly correlated. (That is, each
of the correlation coefficients is between 0 and 1.)
Stock
Expected Return
Standard Deviation
Beta
A
8.32
%
16
%
0.8
B
10.40
16
1.3
C
12.06
16
1.7
Fund P has one-third of its funds invested in each of the three
stocks. The risk-free...

Q3) Consider the following table, which gives a
security analyst’s expected return on two stocks in two particular
scenarios for the rate of return on the market. Assume that both
scenarios are equally likely to happen (i.e., probability of
scenario 1 = probability of scenario 2=0.5).
Q4) You are considering investing in stock S
and you want to know how stock S is related to the market portfolio
M. Given your research, you discovered the following
information:
Expected Return
Standard...

3.
a)
When adding a risky asset to a portfolio of many risky assets,
which property of the asset
is more important, its standard deviation or its covariance with
the other assets? Explain.
b)
Suppose that the risky premium on the market portfolio is estimated
at 8% with a standard deviation of 22%. What is the risk premium of
a portfolio invested 25% in CEMENCO and 75% in Monrovia Breweries,
if they have Betas of 1.1 and 1.25...

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