Question

Consider four assets with the following betas: Beta of Asset A = 1.5; Beta of Asset B = .6; Beta of Asset C = 2.2; and Beta of Asset D = -.9. You invest 20% in each of Assets A and B, while investing 30% each in Assets C and D. Given this, what is the Beta of your Portfolio?
a. .81 b. 1.02 c. 1.35 d. 1.79
7. Which of the following is the correct conclusion of the Static Theory of Capital Structure?
a. Firms should borrow as much money as possible because it is cheaper than equity.
b. Firms should borrow as little as possible because it increases risk more than equity.
c. Firms should balance the tax benefit from tax deductions from debt with increased risk.
d. Firms should be indifferent between debt and equity financing.
8. You bought 300 shares of Firm XYZ five years ago. During the five years, you received a quarterly dividend of $.60 per share, while the price has decreased from $40 to $32. What is the dollar return on your investment?
a. $6,000 b. $5,200 c. $24,00 d. $1,200
9. The current risk-free rate is 3%, while the market risk premium is 8%. If a portfolio has a beta of .45, what is the expected return on the portfolio according to CAPM?
a. 5.2% b. 8.0% c. 6.6% d. 4.3%

Answer 1

Beta of a portfolio is the weighted average of individual Beta of assets in the portfolio.

So, Beta of the portfolio= (0.2*1.5)+(0.2*0.6)+(0.3*2.2)+(0.3*-0.9)= 0.81 (Option a)

7).

c. Firms should balance the tax benefit from tax deductions from debt with increased risk

8).

Given that we receive quarterly dividend of $0.6 per share for 5 years. So, Total dividend per share received over 5 years= 0.6*4*5= $12

Also given that stock price decreased to 32 from 40, a reduction of $8.

So, Dollar return on the investment= 300*(12-8)

= 1200 (Option d)

9).

Given riskfree rate is 3%, market risk premium is 8% and Beta of portfolio is 0.45

According to CAPM, Expected return on the portfolio= rf+Beta*Market risk premium

= 3%+0.45*8%

= 6.6% (Option c)