Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance)
Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance)
3rd Edition
ISBN: 9780133507676
Author: Jonathan Berk, Peter DeMarzo, Jarrad Harford
Publisher: PEARSON
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Chapter 12, Problem 31P
Summary Introduction

Expected return:

Expected return of the market refers to the return earned from the market over and above the risk-free rate of return. Risk-free rate of return, Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  1 is the return that an investor must demand for inflation and the time-value of money, even when there is hardly any risk of any financial loss. Risk premium varies with the systematic risk in an investment. It is the market risk premium multiplied by the beta (ß) of a security. It is determined as the market risk premium multiplied by the beta of the security. The market risk premium is equal to the expected market return less the return earned from risk-free security.

The expected return can be calculated using the formula given below.

Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  2

Where,

  • Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  3 is the expected return.
  • Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  4 is the risk free rate of return.
  • Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  5 is the beta of the asset.
  • Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  6 is the expected return of the market.

Beta:

Beta Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  7 measures the change in percentage in the excess return of a particular security for 1% change in the excess return of a market portfolio or a benchmark portfolio. The beta Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  8 of a market portfolio is always 1. However, the securities may have either higher or lower betas as compared to the beta of the market portfolio. The primary reason for this difference is the sensitivity of the individual industries to the economy.

The beta Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  9 of a portfolio is the weighted average beta of the overall stocks in a portfolio.

The beta Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  10 of a portfolio with three stocks, Stock E, Stock C, and Stock K can be calculated using the formula given below.

Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  11

Where,

  • Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  12 is the beta of a portfolio.
  • Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance), Chapter 12, Problem 31P , additional homework tip  13 is the weight of a stock.

To determine:

Whether the stock must be bought.

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Fundamentals of Corporate Finance (3rd Edition) (Pearson Series in Finance)

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