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Suppose the market portfolio is equally likely to increase by 40% or decrease by 2%. Also suppose that the risk-free interest rate is 6%. a. Use the beta of a firm that goes up on average by 60% when the market goes up and goes down by 5% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return? b. Use the beta of a firm that goes up on average by 10% when the market goes down and goes down by 9% when the market goes up to estimate the expected return of its stock. How does this compare with the stock's actual expected return?

Suppose the market portfolio is equally likely to increase by 40% or decrease by 2%. Also suppose that the risk-free interest rate is 6%. a. Use the beta of a firm that goes up on average by 60% when the market goes up and goes down by 5% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return? b. Use the beta of a firm that goes up on average by 10% when the market goes down and goes down by 9% when the market goes up to estimate the expected return of its stock. How does this compare with the stock's actual expected return?

Essentials Of Investments
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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Do 3 steps for both part A and B please 

Suppose the market portfolio is equally likely to increase by 40% or decrease by 2%. Also suppose that the risk-free interest rate is 6%. a. Use the beta of a firm that goes up on average by 60% when the market goes up and goes down by 5% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return? b. Use the beta of a firm that goes up on average by 10% when the market goes down and goes down by 9% when the market goes up to estimate the expected return of its stock. How does this compare with the stock's actual expected return? a. Use the beta of a firm that goes up on average by 60% when the market goes up and goes down by 5% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return? The beta of the stock is 1.55. (Round to two decimal places.) The expected return of the market is 19.00%. (Round to two decimal places.) According to the CAPM, the expected return of the stock should be (Round to two decimal places.) %.
Transcribed Image Text:Suppose the market portfolio is equally likely to increase by 40% or decrease by 2%. Also suppose that the risk-free interest rate is 6%. a. Use the beta of a firm that goes up on average by 60% when the market goes up and goes down by 5% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return? b. Use the beta of a firm that goes up on average by 10% when the market goes down and goes down by 9% when the market goes up to estimate the expected return of its stock. How does this compare with the stock's actual expected return? a. Use the beta of a firm that goes up on average by 60% when the market goes up and goes down by 5% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return? The beta of the stock is 1.55. (Round to two decimal places.) The expected return of the market is 19.00%. (Round to two decimal places.) According to the CAPM, the expected return of the stock should be (Round to two decimal places.) %.
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