Assignment 10

Subject: Financia; strategy & policy Question No 2    (part i)                                                                             Answer the following. i) Consider the following information for three stocks, Stocks X, Y, and Z. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is, each of the correlation coefficients is between 0 and 1.) Stock Expected return Standard deviation beta X 9.00% 15% 0.8 Y 10.75 15 1.2 Z 12.50 15 1.6 Fund Q has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the market is in equilibrium. (that is, required returns equal expected returns.) a) What is the market risk premium (rM – rRF)? b) What is the beta of Fund Q? c) What is the expected return of Fund Q? d) Would you expect the standard deviation of Fund Q to be less than 15%, equal to 15%, or greater than 15%? Explain.

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QUESTION 1 Exhibit 5.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)   Stock Rit Rmt ai Beta A 10.6 15 0 0.8 Z 9.8 8.0 0 1.1   Rit = return for stock i during period t Rmt = return for the aggregate market during period t   Refer to Exhibit 5.5. What is the abnormal rate of return for Stock A during period t using only the aggregate market return (ignore differential systematic risk)?   a. 4.40   b. −1.70   c. 3.40   d. −4.40   e. −1.86

Q#10: Chapter 08: The index model has been estimated for stocks A and B with the following results: RA= 0.01 +0.5RM + eA. RB = 0.02 + 1.3RM + eB. OM = 0.25; σ(EA) = 0.20; σ(eB) = 0.10. a. b. The covariance between the returns on stocks A and B is The standard deviation for stock A is The standard deviation for stock B is C. d. Discuss the advantages of the single-index model over the Markowitz model.

Question 1Fill the parts in the above table that are shaded in yellow. You will notice that there are nineline items. Question 2 Using the data generated in the previous question (Question 1)a) Plot the Security Market Line b) Superimpose the CAPM’s required return on the SML c) Indicate which investments will plot on, above and below the SML?d) If an investment’s expected return (mean return) does not plot on the SML, what doesit show? Identify undervalued/overvalued investments from the graph

K (Expected rate of return and risk) Syntex, Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on the risk (as measured by the standard deviation) and return? Common Stock A Probability 0.20 0.60 0.20 Common Stock B Return 13% 17% 18% Probability 0.10 0.40 0.40 0.10 (Click on the icon in order to copy its contents into a spreadsheet.) Return -7% 5% 16% 21% www a. Given the information in the table, the expected rate of return for stock A is 16.40 %. (Round to two decimal places.) The standard deviation of stock A is 1.74 %. (Round to two decimal places.) b. The expected rate of return for stock B is 9.8 %. (Round to two decimal places.) The standard deviation for stock B is 6.12 %. (Round to two decimal places.)

Q1: Explain the meaning and significance of a stock's beta coefficient. Illustrate your explanation by drawing, on one graph, the characteristic lines for stocks with low, average, and high risk. (Hint: Let your three characteristic lines intersect at r_i=r_m=6%, the assumed risk-free rate.) Q2: Define the following terms, using graphs or equations to illustrate your answers where feasible. a) Risk, stand-alone risk b) Expected rate of return c) standard deviation, variance d) risk premium for stock i, market risk premium e) Capital Asset Pricing Model (CAPM) f) Expected return on a portfolio g) market risk, diversifiable risk h) Beta i) Security Market Line; SML equation j) Slope of SML and its relationship to risk aversion. Q3. Differentiate between (a) stand-alone risk and (b) risk in a portfolio context. How are they measured, and are both concepts relevant for investors? Q4. Can an investor eliminate market risk from a portfolio of common stocks? How many stocks must a portfolio…

Problem 8.13 (CAPM, Portfolio Risk, and Return) Consider the following information for stucks A, B, and C. The returns on the three stocks positively correlated, but they are not perfectly correlated. That is, each of the correlation Coefficients is between 0 and 1₁) ame Stock Expected Return Stendanction Beta A 6.25% 15% 0.7 B 7.50 15 8.50 15 C 112 1.6 Find P has one-third of its funds invested of each of the three stocks. The risk-free rate is 4.5%, and the market is in equilibrium. (That is required returns equal expected returns) a) What is the market risk premium (YM-XRF)? 5) What is the beta of Fund P? c) What is the required return of Fund P?

Question 1 Fill the parts in the above table that are shaded in yellow. You will notice that there are nineline items.  Question 2Using the data generated in the previous question (Question 1);a) Plot the Security Market Line (SML) b) Superimpose the CAPM’s required return on the SML c) Indicate which investments will plot on, above and below the SML? d) If an investment’s expected return (mean return) does not plot on the SML, what doesit show? Identify undervalued/overvalued investments from the graph

A 1 Data for Two Stocks 2 3 B C D E F G H J K 2. Use the Excel file Data for Two Stocks to determine the following: a. Using EXCEL's Data Table Feature, create a one-way data table that determines the different means and standard deviations for portfolios consisting of combinations of Stock A and Stock B by varying the correlation coefficient value between Stock A and Stock B through the full range of possible correlation coefficient values. Use increments of 0.10 for the possible correlation coefficient values. b. Graph the correlation coefficients, the means, and the standard deviations of the portfolios from the one-way data table. Be sure to include a title for the graph and label the axes. c. Use Excel's Text Box Feature to explain how the portfolio means are affected by changing the correlation coefficient values. d. Use Excel's Text Box Feature to explain how the portfolio standard deviations are affected by changing the correlation coefficient values. 4 5 Expected return A B…

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM   Stock Rit Rmt ai Beta C 12 10 0 0.8 E 10 8 0 1.1   Rit = return for stock i during period t  Rmt = return for the aggregate market during period t    What is the abnormal rate of return for Stock C during period t using only the aggregate market return (ignore differential systematic risk)?

b. Consider the following information about three stocks: Probability of State of i. ii. iii. iv. State of Economy V. Boom Recession Economy 0.40 0.60 From the information given, you are required to answer the following questions. Compute the Standard Deviation for each stock. Compute the Coefficient Variation for each stock. Based on your computation in part (i) and (ii), which stock is riskier? Explain your answer. Rate of Return if State Occurs Stock Hang Stock Hang Jebat 7% 13% Tuah 28% (5%) Stock Hang Kasturi 15% 3% Assume that you have RM14,000 invested in Stock Hang Jebat whose beta is 1.5, RM19,000 invested in Stock Hang Kasturi whose beta is 2.5 and RM17,000 invested in Stock Hang Tuah whose beta is 1.6. Determine what is the beta of this portfolio. Based on your answer in part (iv), compute the required rate of return for this portfolio, given that the market rate of return is 13% and risk-free rate is 5%.

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Problem 1 You are given the following information about stock X and the market portfolio, M: Riskless Asset (f) Stock X Market Portfolio (M) E(r) 0.04 (4%) ? 0.10 σ 0.00 0.30 0.20 You are not given the expected return of stock X. The correlation of the returns on the stock X and the market portfolio is equal to 0.4. a) What is the beta (6) of stock X? b) Assuming the CAPM holds, what is the expected return on stock X? c) You have $1,000 to invest in some combination of the risk-free asset, stock X, and the market portfolio. You are thinking of investing $300 in the risk free asset, $400 in stock X, and $300 in the market portfolio. What is the overall expected return, standard deviation and beta of this portfolio?

stions Problem 8.13 (CAPM, Portfolio Risk, and Return) eBook Problem Walk-Through Question 11 of 15▸ Check My Work Consider the following information for stocks A, B, and C. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is, each of the correlation coefficients is between 0 and 1.) Stock Expected Return Standard Deviation Beta A 8.50% 16% 0.8 C 9.25 10.75 16 16 1.1 1.7 Fund P has one-third of its funds invested in each of the three stocks. The risk-free rate is 6.5%, and the market is in equilibrium. (That is, required returns equal expected returns.) a. What is the market risk premium (rM - TRF)? Round your answer to one decimal place. % b. What is the beta of Fund P? Do not round intermediate calculations. Round your answer to two decimal places. c. What is the required return of Fund P? Do not round intermediate calculations. Round your answer to two decimal places. % d. What would you expect the standard deviation of Fund P…

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b) Suppose that you observe the following information in Table 2 for stocks A and B: Table 2 Expected Return (%) 11% Stock Beta A 0.8 В 14% 1.5 The risk-free rate of return is 6% and the expected rate of return on the market index is 12%. Using the Single-Index Model, calculate the alpha of both stocks. Show your calculations. Explain what the alpha of the single-factor model represents and interpret your results.

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Exercises: a. The standard deviation of returns is 0.30 for Stock A and 0.20 for Stock B. The covariance between the returns of A and B is 0.006. The correlation of returns between A and B is: b. Explain the differences between systemic risk and unsystematic risk, give additional examples c. Compare and contrast the Capital Market Line and Security Market Line d. The covariance of the market's returns with the stock's returns is 0.008. The standard deviation of the market's returns is 0.08, and the standard deviation of the stock's returns is 0. 11. What is the correlation coefficient of the returns of the stock and the returns of the market? e. According to the CAPM, what is the required rate of return for a stock with a beta of 0.7, when the risk-free rate is 7% and the expected market rate of return is 14%

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The beta coefficient A stock’s contribution to the market risk of a well-diversified portfolio is called Q1. ______risk. It can be measured by a metric called the beta coefficient, which calculates the degree to which a stock moves with the movements in the market.   Q2. Based on your understanding of the beta coefficient, indicate whether each statement in the following table is true or false: Statement True False Over time, a stock with a beta of 1.0 produces a return that goes up and down with a 1:1 relationship with the return on the market.       Beta measures the volatility in stock movements relative to the market.       A stock that is more volatile than the market will have a beta of less than 1.0.     Q1. Option 1 Unsystematic or Option 2 Relevant.  Please provide true or false answers. Thank you!