Consider the following information about two stocks (D and E) and two common risk factors (factor 1 and factor 2)StockRisk factor 1Risk factor 2Expected return (%)D1.23.413.12.62.615.4a. Assuming that the risk free rate is 5%, determine the risk premium for factors 1 and 2 that are consistent with the expected returns for the two stocks.You expect that in one year the prices of Stock D and E will be $55 and $36 respectively and pay no dividends. What should be the price of each stock today to be consistent with the expected return levels.b.C.Determine how to you identified if Stock D and E are overvalued, fairly valued and undervalued?d. Suppose the risk premium for factor 1 as computed in (a) increases by 0.25 percent, what will be the new expected return for D and E?e. Suppose the risk premium for factor 1 as computed in (a) decreases by 0.25%, what will be the new expected return for D and E?f. Devise how would you develop a Jensen Index using Arbitrage Pricing Theory. Illustrate with appropriate example.

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Answered: Consider the following information…

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: A stock has an expected return of 9.7 percent, its beta is .89, and the risk-free rate is 2.9 percent. What must the expected return on the market be?
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Finance
Currently the risk-free rate equals 5% and the expected return on the market portfolio equals 11%. An investment analyst provides you with the following information: Stock A Beta 1.33 Expected Return 12% Stock B Beta 0.7 Expected Return 10% (a) Calculate the reward-to-risk ratios of stock A, stock B and in market equilibrium. Are stock A and stock B overvalued, undervalued or fairly valued? Briefly explain. [within 150 words] (b) You want a portfolio with the same risk as the market. Calculate the weights of stock A and B respectively. (please show me steps and round the final answer to 2 decimal places, thanks)
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Consider the following simplified APT model: Factor Expected Risk Premium Market 6.4% Interest Rate -0.6% Yield Spread 5.1% Factor Risk Exposures Market Interest Rate Yield Spread Stock Stock(b1) (b2) (b3) P 1.0 -2.0 -0.2 P2 1.2 0 0.3 P3 0.3 0.5 1.0 Required: 1. Calculate the expected return for the above stocks. Assume risk free rate is 5%. Consider a portfolio with equal investments in stocks P, P2 and P3 2.What are the factor risk exposures for the portfolio? 3.What is the portfolio’s expected return?
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