Question

3-If you take out a three-year car loan for $24,540 at an interest rate of 7.73%, what are your monthly payments?

4-What is the expected annual return on Caterpillar if it has a beta of 0.90; the annual one-year Treasury bill rate is 2.24%%; and the expected return on the Standard & Poor’s 500 is 8%? Also, please explain, in a few sentences, the intuition behind your result (i.e., the relationship between beta and expected return).

Answer 1

3	Loan Amount (PV)	24540
	Interest Rate ('r)	7.73%
	No of years (n)	3
	m	12
	r/m=0.0773/12	0.00644
	n*m=3*12	36
	Payment (P)=	r/m*(PV)/(1-(1+r/m)^-n*m)
	=	0.00644*(24540)/(1-(1+0.00644)^-36
	=	765.92

Monthly Payment is $765.92

4	Beta	0.9
	Risk Free Rate	2.24%
	Market Return	8%
	Expected Return =	Risk Free Rate + Beta * (Market Return - Risk Free Return)
	=	0.0224 + 0.9 *(0.08-0.0224)
	=	0.0742	or 7.42%

Beta is the risk of the asset as compared to overall market return. By multiplying beta by difference of market return and risk free return we calculate the risk premium. Expected return is the sum of risk free return and risk premium.