Question

1.Use the following information to answer the question(s) below.

Suppose that the market portfolio is equally likely to increase by 24% or decrease by 8%. Security "X" goes up on average by 29% when the market goes up and goes down by 11% when the market goes down. Security "Y" goes down on average by 16% when the market goes up and goes up by 16% when the market goes down. Security "Z" goes up on average by 4% when the market goes up and goes up by 4% when the market goes down.

What is the risk free rate?

What is the expected return on market portfolio?

What is the expected return on security with a beta of 0.8 is closest to:

3) What is the expected return on security with a beta of 0.8 is closest to:?1?The excess return is the difference between the average return on a security and the average return for:

A) Corporate Bonds.

B) a portfolio of securities with similar risk.

C) a broad based market portfolio like the S&P 500 index.

D) Treasury Bills.

Use the table for the question(s) below.

Consider the following probability distribution of returns for Alpha Corporation:

Current Stock Price ($)	Stock Price in One Year ($)	Return R	Probability PR
	$35	75%	25%
$20	$25	25%	50%
	$15	-25%	25%

8) What is the the standard deviation of the return on Alpha Corporation?

Answer 1

1. Security Z goes up 4% irrespective of the market portfolio movement, hence it must be the risk free security. Thus the risk free rate is 4%.

Now denoting market return by R_m, we have :

R_x = 29% = 4% + Beta_x * (R_m - 4%) - solving for R_m = 24%, we get Beta_x = 1.25

R_y = -16% = 4% + Beta_y * (R_m - 4%) - solving for R_m = 24%, we get Beta_y = -1

Expected Market Return = 0.5 * 24% + 0.5 * -8% = 8%

Expected Return for stock with Beta 0.8 : 4% + 0.8 * (8%-4%) = 7.20%

3. option (b) a portfolio of security with similar risks

8. Expected Return = 75% * 25% + 25% * 50% + 25% * -25% = 25%

Variance = [25% * (75%-25%)² + 50% * (25%-25%)² + 25% * (-25%-25%)² = 0.125

Standard Deviation = (Variance )^1/2 = 0.125^(1/2) = 35.36%