Question

1. Portfolio Returns. Suppose TinyChip has a beta of 1.6, whereas Bigwing stock has a beta of .8. If the risk-free interest rate is 4% and the expected return of the market portfolio is 10% according to CAPM.
   1. What is the expected return of TinyChip stock? (3 points)
   2. What is the expected return of Bigwing stock? (3 points)
   3. What is the beta of a portfolio of 60% TinyChip and 40% Bigwing stock? (4 points)
   4. What is the expected return of a portfolio of 60% TinyChip and 40% Bigwing stock? (4 points)
   5. Plot the Security Market Line and point out the market portfolio, each company’s stock, and the proposed portfolio above. (4 points)

2. Risk. Suppose you are considering the risk of a portfolio made up of 70% company A stock and 30% company B stock.

	Stock A	Stock B
2011	10.00%	6.00%
2012	7.00%	2.00%
2013	15.00%	5.00%
2014	-5.00%	1.00%
2015	8.00%	-2.00%

1. Calculate the average annual return for each. (5 points)
2. Calculate the volatility of returns for each. (5 points)
3. Calculate the range of values we can be 95% sure returns will fall within for each. (4 points)
4. Suppose you build a portfolio of 25% in A and 75% in B, calculate expected returns, volatility, and a 95% confidence interval for the portfolio. (10 points)

3. Risk and Valuation. Suppose that a company paid a dividend of $.075 this year and expects dividends to grow at 4% indefinitely.
   1. If the company’s beta is 1.2, the market return is 8%, and the risk-free rate is 3%, what is the required rate of return for this company? (3 points)
   2. What is the most you should be willing to pay for a share of stock? (5 points)

Answer 1

I can only answer 4 subparts at a time.

Given: TinyChip has a beta of 1.6, whereas Bigwing stock has a beta of .8
risk free rate = r_f = 4% and market rate = r_m = 10%

a. expected return of TinyChip stock = 4% + 1.6*(10% - 4%) = 13.6%
b. expected return of Bigwing stock = 4% + 0.8*(10% - 4%) = 8.8%
c. beta of a portfolio of 60% TinyChip and 40% Bigwing stock = 0.6*1.6 + 0.4*0.8 = 1.28
d. expected return of a portfolio of 60% TinyChip and 40% Bigwing stock = 4% + 1.28*(10% - 4%) = 11.68%

Please do rate me and mention doubts, if any, in the comments section.