Question

Question 1

A) If the economy is normal, Stock A is expected to return 10.50%. If the economy falls into a recession, the stock's return is projected at a negative 14%. If the economy is in a boom the stock has a projected return of 16.9% The probability of a normal economy is 60% while the probability of a recession is 20% and boom is 20%. What is the expected return of this stock? Answer as % and to first decimal.

B) A stock has a beta of 1.09, the expected return on the market is 9%, and the risk-free rate is 2.5%. What must the expected return on this stock be? Answer as % and to first decimal.

C) Last year stock A had a return of 8 percent and stock B had a return of 12 percent. If you held each stock equally in a portfolio (i.e. 50% in A and 50% in B), what would the return of your portfolio have been? Answer in % and one decimal.

D) A stock has an expected return of 10%, the risk-free rate is 6.0%, and the market risk premium is 4.5%. What must the beta of this stock be? round to first decimal.

Answer 1

1
A) The expected return of Stock =Probability of Boom *Expected Return of Boom+Probability of Normal *Expected Return of Normal+Probability of Recession*Expected Return of Recession =20%*16.9%+60%*10.50%+20%*-14%
=6.88%

2. Expected Return of Stock =Risk Free Rate+beta*(Market Return-Risk free Rate) =2.5%+1.09*(9%-2.5%) =9.59%

3. Return of Portfolio =50%*8%+50%*12% =10%

4. Beta of Stock =(Expected Return of Stock -Risk free Rate)/Beta =(10%-6%)/4.5% =0.89 or 0.9