3. On a market at equilibrium stocks A (ß-1.2) and B (ß-0.7) offer returns of 15% and 10%, respectively. The standard deviation of the market index is 25%. An investor with a total budget of 120000 lei will buy 960 A shares for 48000 lei, 3600 B shares for 36000 lei, the difference being invested in stock C. The specific risk of this portfolio is zero and the variance of portfolio's returns is 8.1225%. a. Compute the rate of return on the portfolio b. The manager of company A decides to invest 40% of the annual EPS in projects that generate a return of 20% per year. EPS is in value of 10 lei. How will the price of the stock change? c. The manager of company B will implement a project that demands for an investment of 3.5 lei per share and generates over the next 20 years cash-flows of 1.1 lei per share. What is the impact on the stock's price?

3. On a market at equilibrium stocks A (ß-1.2) and B (ß-0.7) offer returns of 15% and 10%, respectively. The standard deviation of the market index is 25%. An investor with a total budget of 120000 lei will buy 960 A shares for 48000 lei, 3600 B shares for 36000 lei, the difference being invested in stock C. The specific risk of this portfolio is zero and the variance of portfolio's returns is 8.1225%. a. Compute the rate of return on the portfolio b. The manager of company A decides to invest 40% of the annual EPS in projects that generate a return of 20% per year. EPS is in value of 10 lei. How will the price of the stock change? c. The manager of company B will implement a project that demands for an investment of 3.5 lei per share and generates over the next 20 years cash-flows of 1.1 lei per share. What is the impact on the stock's price?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Question

3. On a market at equilibrium stocks A (B-1.2) and B (B-0.7) offer returns of 15% and 10%,
respectively. The standard deviation of the market index is 25%. An investor with a total budget
of 120000 lei will buy 960 A shares for 48000 lei, 3600 B shares for 36000 lei, the difference
being invested in stock C. The specific risk of this portfolio is zero and the variance of
portfolio's returns is 8.1225%.
a. Compute the rate of return on the portfolio
b. The manager of company A decides to invest 40% of the annual EPS in projects that
generate a return of 20% per year. EPS is in value of 10 lei. How will the price of the stock
change?
c. The manager of company B will implement a project that demands for an investment of 3.5
lei per share and generates over the next 20 years cash-flows of 1.1 lei per share. What is
the impact on the stock's price?

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Consider 2 scenarios: Boom Economy and Normal Economy. The Boom economy has 30% chance of happening, while Normal economy has 70% chance of happening. For each scenario (Boom and Normal), stock ABC has a return of 25%, and 4%, respectively; stock XYZ has a return of 10% and 6.5%, respectively; the market portfolio has a return of 12% and 5% respectively. 1) Calculate Expected return, Variance and Standard deviation for stock ABC and XYZ 2) Based on your results in part (1), can you decide which stock to invest? 3) Calculate Beta for stock ABC and XYZ 4) If the T-bill rate is 3%, what does the CAPM say about the fair expected rate of return on the two stocks? How does this result influence your investment decision?

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