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, 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. Where, is the expected return. is the risk free rate of return. is the beta of the asset. is the expected return of the market. Beta: Beta 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 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 of a portfolio is the weighted average beta of the overall stocks in a portfolio. The beta of a portfolio with three stocks, Stock E, Stock C, and Stock K can be calculated using the formula given below. Where, is the beta of a portfolio is the weight of a stock To determine: The best estimate of investors’ expected return on the company’s stock.

Question

Want to see the full answer?

Answer 1

Question

Chapter 12, Problem 35P

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, 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.

Where,

is the expected return.

is the risk free rate of return.

is the beta of the asset.

is the expected return of the market.

Beta:

Beta 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 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 of a portfolio is the weighted average beta of the overall stocks in a portfolio.

The beta of a portfolio with three stocks, Stock E, Stock C, and Stock K can be calculated using the formula given below.

Where,

is the beta of a portfolio

is the weight of a stock

To determine:

The best estimate of investors’ expected return on the company’s stock.

Expert Solution & Answer

Want to see the full answer?

Check out a sample textbook solution

See solution

Students have asked these similar questions

Define the following: Callable bond Puttable bond Zero-coupon bond Premium bond Discount bond Crossover bonds Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose a German company issues a bond with a par value of EUR 1,000, 15 years to maturity, a coupon rate of 7.2%. If the yield to maturity is 6.3%, what is the current price of the bond? Rhiannon Corporation has bonds on the market with 13 years to maturity, a YTM of 7.6%, a par value of $1,000, a current market price of $1,075. The bonds make semiannual payments. What must the coupon rate be on these bonds? What would be coupon rate if the current market price is $962.68? What would be the coupon rate if the bonds make quarterly payments? Suppose that a bond has a face value of $1,000 and a YTM of 8% per annum. If the bond pays monthly coupons with an annual coupon rate of 9.6%, what will be the current price of…

Wildcat, Incorporated, has estimated sales (in millions) for the next four quarters as follows: Q1 Q2 Q3 Sales $ 195 $ 215 $ 235 Q4 $ 265 Sales for the first quarter of the following year are projected at $210 million. Accounts receivable at the beginning of the year were $83 million. Wildcat has a 45-day collection period. Wildcat's purchases from suppliers in a quarter are equal to 50 percent of the next quarter's forecast sales, and suppliers are normally paid in 36 days. Wages, taxes, and other expenses run about 20 percent of sales. Interest and dividends are $18 million per quarter. Wildcat plans a major capital outlay in the second quarter of $98 million. Finally, the company started the year with a $84 million cash balance and wishes to maintain a $40 million minimum balance. a-1. Assume that Wildcat can borrow any needed funds on a short-term basis at a rate of 3 percent per quarter and can invest any excess funds in short-term marketable securities at a rate of 2 percent per…

Consider the following two bonds: Bond A Bond B Face value $1,000 $1,000 Coupon rate (annual) 8% 8% YTM 9% 7% Maturity 10 years 10 years Price (PV) ? ? Calculate the price for each bond. What is the primary factor affecting the prices of the bonds? Indicate which bond is premium and which one is discount. Is there any relationship between the YTM and the coupon rate in case of premium/discount bonds? Now, consider the following two bonds: Bond X Bond Y Face value $1,000 $1,000 Coupon rate (annual) 8% 8% YTM 11% 11% Maturity 5 years 10 years Price (PV) ? ? Calculate the price for each bond. What is the relationship between bond price and maturity, all else equal? A bond with a par value of $1,000 and a maturity of 8 years is selling for $925. If the annual coupon rate is 7%, what’s the yield on the bond? What would be the yield if the bond had semiannual payments?…