Question

1) Your stock has a β = 2.99, the expected return on the stock market is 10.92%, and the yield on T-bills is 5%. What is the expected return on your stock?

2) Suppose you hold a portfolio of two stocks in the healthcare industry. The future outcomes for these stocks depend mainly on the next healthcare bill to be passed by Congress. The possible outcomes and returns are:

Outcome	Probability	Return for Stock A	Return for Stock B
1=Republican Bill	0.8	12%	-5%
2=Democratic Bill	0.2	3%	20%

What is the expected return and a standard deviation of a portfolio that has 50% of its value in stock A and 50% in stock B?

Group of answer choices

9.9% and 3.2%

7.5% and 4%

5.1% and 3.2%

Answer 1

1)

CAPM equation is widely used to calculate expected return on the security. As per CAPM there is positive and linear relationship between expected return and systematic risk as measured by beta.

According to capital asset pricing model -

E(Ri) = Rf + ( E(Rm) - Rf ) * beta of security

where,

E(Ri) = Expected return on security i

rf = risk free return

E(Rm) = Expected market return

Here,  β = 2.99

Expected market return = 10.92%

Risk free return = 5%

(Note :- T- bills are considered as risk free security as these are issued by the government and are backed by the treasury. Hence, yield on T-bills is the risk free return)

E(Ri) = Rf + ( E(Rm) - Rf ) * beta of security

Expected return = 5 + ( 10.92 - 5 ) * 2.99

= 5 + ( 5.92 ) * 2.99

= 5 + 17.7008

= 22.7008 %

Hence, expected return on the stock = 22.70 % ( approx)

Hope it helps!