Q2(a) There are two stocks in the market, Stock A and Stock B. The price of Stock A today is GHe 79. The price of Stock A next year will be GH¢64 if the economy is in a recession, GH¢ 87 if the economy is normal, and GH¢97 if the economy is expanding. The probabilities of recession, normal times, and expansion are 0.4, 0.4, and 0.2, respectively. Stock A pays no dividends and has a correlation of 0.7 with the market portfolio. Stock B has an expected return of 14 percent, a standard deviation of 25 percent, a correlation with the market portfolio of 0.24, and a correlation with Stock A of 0.36. The market portfolio has a standard deviation of 18 percent. Assume the CAPM holds. i. If you are a typical, risk-averse investor with a well-diversified portfolio, which stock would you prefer? Why? ii. What are the expected return and standard deviation of a portfolio consisting of 60 percent of Stock A and 40 percent of Stock B ? 111. What is the beta of the portfolio in part (ii)? Q2(b) Carefully reflect on the Capital Asset Pricing Model and Arbitrage Pricing Theory. Briefly explain two features common to them.
Q2(a) There are two stocks in the market, Stock A and Stock B. The price of Stock A today is GHe 79. The price of Stock A next year will be GH¢64 if the economy is in a recession, GH¢ 87 if the economy is normal, and GH¢97 if the economy is expanding. The probabilities of recession, normal times, and expansion are 0.4, 0.4, and 0.2, respectively. Stock A pays no dividends and has a correlation of 0.7 with the market portfolio. Stock B has an expected return of 14 percent, a standard deviation of 25 percent, a correlation with the market portfolio of 0.24, and a correlation with Stock A of 0.36. The market portfolio has a standard deviation of 18 percent. Assume the CAPM holds. i. If you are a typical, risk-averse investor with a well-diversified portfolio, which stock would you prefer? Why? ii. What are the expected return and standard deviation of a portfolio consisting of 60 percent of Stock A and 40 percent of Stock B ? 111. What is the beta of the portfolio in part (ii)? Q2(b) Carefully reflect on the Capital Asset Pricing Model and Arbitrage Pricing Theory. Briefly explain two features common to them.
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
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Transcribed Image Text:Q2(a) There are two stocks in the market, Stock A and Stock B. The price of Stock A today is GHe 79. The price
of Stock A next year will be GH¢64 if the economy is in a recession, GH¢ 87 if the economy is normal, and
GH¢97 if the economy is expanding. The probabilities of recession, normal times, and expansion are 0.4, 0.4,
and 0.2, respectively. Stock A pays no dividends and has a correlation of 0.7 with the market portfolio. Stock B
has an expected return of 14 percent, a standard deviation of 25 percent, a correlation with the market portfolio
of 0.24, and a correlation with Stock A of 0.36. The market portfolio has a standard deviation of 18 percent.
Assume the CAPM holds.
i.
If you are a typical, risk-averse investor with a well-diversified portfolio, which stock would you
prefer? Why?
ii.
What are the expected return and standard deviation of a portfolio consisting of 60 percent of Stock A
and 40 percent of Stock B ?
111.
What is the beta of the portfolio in part (ii)?
Q2(b) Carefully reflect on the Capital Asset Pricing Model and Arbitrage Pricing Theory. Briefly explain two
features common to them.
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