Question

FIN220 – Practice Questions (Module 3)

1. A stock’s expected return has the following distribution:

DEMAND FOR THE COMPANY’S PRODUCTS	PROBABILITY OF THIS DEMAND OCCURRING	RATE OF RETURN IF THIS DEMAND OCCURS (%)
Weak	0.1	(50)
Below Average	0.2	(5)
Average	0.4	16
Above Average	0.2	25
Strong	0.1	60

       Calculate the stock’s expected return and standard deviation.

2. Selena Maranjian invests the following sum of money in common stock having expected returns as follows:

Common Stock	Amount Invested in $	Expected Return
WOOPS	6,000	0.14
KABOOM	11,000	0.16
KAPOWW	9,000	0.17
UPDWN	7,000	0.13
RINGG	5,000	0.20

3. Stocks X and Y have the following probability distributions of expected future returns:

Probability	X	Y
0.1	-10%	-35%
0.2	2%	0%
0.4	12%	20%
0.2	20%	25%
0.1	38%	45%

1. Calculate the expected rate of return, ?̂ , for Stock Y. Return for Stock X, (?̂_X =12%).
2. Calculate the standard deviation of expected returns for Stock X. (That for Stock Y is 20.35 percent.)

4. Suppose R_F = 5%, R_M = 10%, and R_A = 12%.
   1. Calculate Stock A’s beta.
   2. If Stock A’s beta were 2.0, what would be A’s new required rate of return?

Answer 1

Answer 1
Demand	Probability	Rate of Return	(AR * Prob.)	ER	Variance
					(AR-ER)^2 * Pro.
Weak	0.1	-50.00	-5.00	11.4	376.996
Below Average	0.2	-5.00	-1.00	11.40	53.792
Average	0.4	16.00	6.40	11.40	8.464
Above Average	0.2	25.00	5.00	11.40	36.992
Strong	0.1	60.00	6.00	11.40	236.196
		ER=	11.4		712.44
		Variance =			712.44
		Std. Dev. = SQRT(Variance)			26.69157
Stock Expected return is 11.40% and standard deviation is 26.69%