2. Suppose that three stocks (A, B, and C) and two common systematic risk factors (1 and 2) have the following relationship: E(RA) = (0.80) F1 + (0.90) F2 E(RB)= (-0.20) F1 + (1.30) F2 E(RC)= (1.80) F1 + (0.50) F2 a. Compute the expected returns if F1 = 4% and F2 = 5% b. Assuming that all three stocks are currently priced at $35 and will not pay a dividend over the next year, compute the expected prices a year from now c. Now, suppose you "know" that in one year the actual prices of stocks A, B, and C will be $37.20, $37.80, and $38.50. How can you best take advantage of what you consider to be a market mispricing? d. How will the current prices adjust?
2. Suppose that three stocks (A, B, and C) and two common systematic risk factors (1 and 2) have the following relationship: E(RA) = (0.80) F1 + (0.90) F2 E(RB)= (-0.20) F1 + (1.30) F2 E(RC)= (1.80) F1 + (0.50) F2 a. Compute the expected returns if F1 = 4% and F2 = 5% b. Assuming that all three stocks are currently priced at $35 and will not pay a dividend over the next year, compute the expected prices a year from now c. Now, suppose you "know" that in one year the actual prices of stocks A, B, and C will be $37.20, $37.80, and $38.50. How can you best take advantage of what you consider to be a market mispricing? d. How will the current prices adjust?
Chapter6: Risk And Return
Section: Chapter Questions
Problem 1Q
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Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Question
Transcribed Image Text:2. Suppose that three stocks (A, B, and C) and two common systematic risk factors (1 and 2)
have the following relationship:
E(RA) = (0.80) F1 + (0.90) F2
E(RB)= (-0.20) F1 + (1.30) F2
E(RC)= (1.80) F1 + (0.50) F2
a. Compute the expected returns if F1 = 4% and F2 = 5%
b. Assuming that all three stocks are currently priced at $35 and will not pay a dividend over the
next year, compute the expected prices a year from now
c. Now, suppose you "know" that in one year the actual prices of stocks A, B, and C will be
$37.20, $37.80, and $38.50. How can you best take advantage of what you consider to be a
market mispricing?
d. How will the current prices adjust?
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