Question

1. McDowell Company's stock has a beta of 0.9, the risk-free rate is 2.8%, and the return on the market is 9.4%. McDowell's required return is ____ %.

2. If a stock’s price in general decreases, when the stock market goes up, but yet the stock’s price does not decrease as much as the stock market increases, the stock’s beta must be:

a) negative.

b) between -1 and zero.

c) between zero and 1.

d) larger than 1.

3. The relevant risk that a prudent investor should consider in his/her investment decisions is:

a) The investment's market risk.

b) Diversifiable risk of the investment.

c) The total risk the portfolio was exposed to.

d) The Company specific risk of the investment(s).

4. The following stocks is overvalued:

	Expected Rate of Return	Required Rate of Return
Stock A	13.60%	13.50%
Stock B	14.00%	14.00%
Stock C	15.00%	14.00%
Stock D	6.50%	7.00%

a) Stock A

b) Stock B

c) Stock C

d) Stock D

PLEASE ANSWER ALL QUESTIONS

Answer 1

1. required rate of return=risk free rate+(beta*(market return-risk free rate))=2.8%+(0.9*(9.4%-2.8%))=2.8%+5.94%=8.74%

2. Beta of 1 is the market risk. If beta is less than 1, the stock price will not move in tandem with the market returns.

Hence, the beta lies between 0 to 1.

3. The market risk can't mitigated, but the Diversifiable riks can be mitigated by adding more stocks to the portfolio.

Option b is correct

4. If the required rate of return is greater than expected rate of return, then the stock is over valued.

Here Stock D has this type of set up. Hence, stock D is over valued.