a.
Adequate information:
| Price of Stock A today (P0) | $75 | |
| Price of Stock A in Next Year | Probability | |
| Recession | $64 (P1) | 0.20 (PR) |
| Normal | $87 (P2) | 0.60 (PN) |
| Expanding | $97 (P3) | 0.20 (PE) |
Stock A correlation with market (?A,M) = 0.70
Expected return on Stock B [E(RB)] = 14%
Standard deviation of Stock B (σB) = 34%
Stock B correlation with market (ρB,M) = 0.24
Stock B correlation with Stock A (ρB,A) = 0.36
Market standard deviation (σM) = 18%
To compute: Which stock would be preferred by an investor, if the investor is risk-averse?
Introduction: Systematic risk also known as non-diversifiable risk and is measured by the value of beta. The higher the value of beta, the higher the value of the systematic risk.
b.
Adequate information:
| Price of Stock A today (P0) | $75 | |
| Price of Stock A in Next Year | Probability | |
| Recession | $64 (P1) | 0.20 (PR) |
| Normal | $87 (P2) | 0.60 (PN) |
| Expanding | $97 (P3) | 0.20 (PE) |
Stock A correlation with market (ρA,M) = 0.70
Expected return on Stock B [E(RB)] = 14%
Standard deviation of Stock B (σB) = 34%
Stock B correlation with market (ρB,M) = 0.24
Stock B correlation with Stock A (ρB,A) = 0.36
Market standard deviation (σM) = 18%
Weight of Stock A (WA) = 70% or 0.70
Weight of Stock B (WB) = 30% or 0.30
To compute: The expected return and standard deviation of the portfolio.
Introduction: Expected return simply refers to the return that is anticipated on the investment.
c.
Adequate information:
| Price of Stock A today | $75 | |
| Price of Stock A in Next Year | Probability | |
| Recession | $64 | 0.2 |
| Normal | $87 | 0.6 |
| Expanding | $97 | 0.2 |
Stock A correlation with market = 0.70
Expected return on Stock B [E(RB)] = 14%
Standard deviation of Stock B (σB) = 34%
Stock B correlation with market = 0.24
Stock B correlation with Stock A = 0.36
Market standard deviation = 18%
Weight of Stock A (WA) = 70% or 0.70
Weight of Stock B (WB) = 30% or 0.30
To compute: Beta of the portfolio
Introduction: The beta of a portfolio shows the systematic risk component of a portfolio.
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Chapter 11 Solutions
CORPORATE FINANCE
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EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT