ESSEN OF INVESTMENTS CONNECT AC
11th Edition
ISBN: 9781266650314
Author: Bodie
Publisher: MCG
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Chapter 6, Problem 21PS
The following figure shows plots of monthly
a. Which stock is riskier to an investor currently holding a diversified portfolio of common stock?
b. Which stock is riskier to an undiversified investor who puts all of his funds in only one of these stocks?
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PART A,B and C are completed. need help in D and E. TIA
Unique vs. Market Risk. The figure below shows plots of monthly rates of return on three stocks versus the stock market index. The beta and standard deviation of each stock is given besides its plot.
A. Which stock is riskiest to a diversified investor?
B. Which stock is riskiest to an undiversified investor who puts all her funds in one of these stocks?
C. Consider a portfolio with equal investments in each stock. What would this portfolio’s beta have been?
D. Consider a well-diversified portfolio made up of stocks with the same beta as Exxon. What are the beta and standard deviation of this portfolio’s return? The standard deviation of the market portfolio’s return is 20 percent.
E. What is the expected rate of return on each stock? Use the capital asset pricing model with a market risk premium of 8 percent. The risk-free rate of interest is 4 percent.
Following are the probability distribution of returns of portfolio of Stock A and Stock B in equal proportion
of weight in each state of economy. You are required to calculate Expected Return and Risk for individual
Stocks?
State of Economy
1
2
3
4
5
Probability
0.2
0.2
0.2
0.2
0.2
Return on Stock A
(%)
15
(5)
5
35
25
Return on Stock B
(%)
(5)
15
25
5
35
If you deposit Rs. 1,000 in the bank at a nominal interest rate of 6 percent, you will have Rs. 1,060 at the
end of the year. Suppose that the inflation rate during the year is also 6 percent. Find real amount in Peso?
You ask a stockbroker what the firm’s research department expects for the three (3) stocksabove, that is, Stock X, Y and Z. The broker responds with the following information:Stock Current Price Expected Price Expected Dividend X 22 24 0.75 Y 48 51 2.00 Z 37 40 1.25Required:B. Calculate the estimated future rate of return for Stock X, Y, and Z. C. Determine which stock is overvalued, undervalued, properly valued, and state whyD. Illustrate with the use of the Security Market Line (SML) how Stock X , Y and Z wouldappear on it.
Chapter 6 Solutions
ESSEN OF INVESTMENTS CONNECT AC
Ch. 6.5 - Prob. 1EQCh. 6.5 - In light of each firm’s exposure to the financial...Ch. 6 - Prob. 1PSCh. 6 - When adding a risky asset to a portfolio of many...Ch. 6 - A portfolio’s expected return is 12%, its standard...Ch. 6 - An investor ponders various allocations to the...Ch. 6 - The standard deviation of the market-index...Ch. 6 - Suppose that the returns on the stock fund...Ch. 6 - Use the rate-of-return data for the stock and bond...Ch. 6 - Prob. 8PS
Ch. 6 - Prob. 9PSCh. 6 - Prob. 10PSCh. 6 - Prob. 11PSCh. 6 - Prob. 12PSCh. 6 - Stocks offer an expected rate of return of 10%...Ch. 6 - Suppose that many stocks are traded in the market...Ch. 6 - You can find a spreadsheet containing annual...Ch. 6 - Assume expected returns and standard deviations...Ch. 6 - Prob. 17PSCh. 6 - Prob. 18PSCh. 6 - A project has a 0.7 chance of doubling your...Ch. 6 - Investors expect the market rate of return this...Ch. 6 - The following figure shows plots of monthly rates...Ch. 6 - Prob. 22PSCh. 6 - Prob. 23PSCh. 6 - Prob. 25CCh. 6 - Prob. 1CPCh. 6 - Prob. 2CPCh. 6 - Abigail Grace has a $900,000 fully diversified...Ch. 6 - Prob. 4CPCh. 6 - Prob. 5CPCh. 6 - Prob. 6CPCh. 6 - Prob. 7CPCh. 6 - Prob. 1WMCh. 6 - Following the procedures in the previous question,...Ch. 6 - Prob. 3WMCh. 6 - Prob. 4WM
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- Consider the three stocks in the following table. Pt represents price at time t, and Qt represents shares outstanding at time t. Stock C splits two for one in the last period. a. A market-value-weighted index. rate of returnb. An equally weighted index. rate of returnarrow_forwardQ3)Unique vs. Market Risk. The figure below shows plots of monthly rates of return on three stocks versus the stock market index. The beta and standard deviation of each stock is given besides its plot. Which stock is riskiest to a diversified investor? Which stock is riskiest to an undiversified investor who puts all her funds in one of these stocks? Consider a portfolio with equal investments in each stock. What would this portfolio’s beta have been? Consider a well-diversified portfolio made up of stocks with the same beta as Exxon. What are the beta and standard deviation of this portfolio’s return? The standard deviation of the market portfolio’s return is 20 percent. What is the expected rate of return on each stock? Use the capital asset pricing model with a market risk premium of 8 percent. The risk-free rate of interest is 4 percent.arrow_forwardSections C through F pleasearrow_forward
- Consider the three stocks in the following table. Pt represents price at time t, and ot represents shares outstanding at time t. Stock C splits two for one in the last period. Stock Po P1 21 75 65 75 75 75 55 150 50 150 50 150 110 150 115 150 60 300 A B с с 20 75 P2 a. Rate of return b. Rate of return Required: Calculate the first-period rates of return on the following indexes of the three stocks (t=0 to t= 1): Note: Do not round intermediate calculations. Round your answers to 2 decimal places. a. A market-value-weighted index. b. An equally weighted index. 22 % %arrow_forwardThe following table represents the rate of returns of two stocks in different economic conditions along with their probabilities (the data are also uploaded on moodle) RATES OF RETURN ON STOCKS EXPECTED ECONOMIC PROBABILITY STOCK A STOCK B CONDITIONS RECESSION 0.55 -0.04 -0.02 STABLE 0.35 0.25 0.30 EXPANDING 0.10 0.15 0.20 Answer the following by using mathematical calculations: a) Calculate the expected rate of return for each stock respectively. Explain what the expected value implies. b) Calculate the standard deviation for each stock respectively. Explain what the standard deviation implies. c) If you were an investor in which stock you were going to invest? Justify your answer. d) Calculate the covariance between Stock A and stock B. Discuss. e) Calculate the expected return and the standard deviation of the portfolio consisting 40% in stock A and 60% in stock B. f) Discuss the risk and return associated with investing i All of your funds in stock A ii. All of your funds in stock…arrow_forwardcan you do the question b pleasearrow_forward
- The following graph plots the current security market line (SML) and indicates the return that investors require from holding stock from Happy Corp. (HC). Based on the graph, complete the table that follows: 00.51.01.52.020.016.012.08.04.00REQUIRED RATE OF RETURN (Percent)RISK (Beta)Return on HC's Stock CAPM Elements Value Risk-free rate (rRFrRF) Market risk premium (RPMRPM) Happy Corp. stock’s beta Required rate of return on Happy Corp. stock An analyst believes that inflation is going to increase by 2.0% over the next year, while the market risk premium will be unchanged. The analyst uses the Capital Asset Pricing Model (CAPM). The following graph plots the current SML. Calculate Happy Corp.’s new required return. Then, on the graph, use the green points (rectangle symbols) to plot the new SML suggested by this analyst’s prediction. Happy Corp.’s new required rate of return is . Tool tip: Mouse over the points on…arrow_forwardUsing the data in the chart, calculate the first-period rates of return on the following indexes of the three stocks: A market-value-weighted index. An equally weighted index. stocks P0 Q0 P1 Q1 P2 Q2 A 90 100 95 100 95 100 B 50 200 45 200 45 200 C 100 200 110 200 55 400 (Pt represents price at time t, and Qt represents shares outstanding at time t.)arrow_forwardConsider the following table, which gives a security analyst's expected return on two stocks in two particular scenarios for the rate of return on the market: Market Return Aggressive Stock -4% 38 6% 24 Aggressive stock Defensive stock a. What are the betas of the two stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Beta Aggressive stock Defensive stock Defensive Stock b. What is the expected rate of return on each stock if the two scenarios for the market return are equally likely to be 6% or 24%? (Do not round intermediate calculations. Round your answers to 1 decimal place.) Expected Rate of Return 5% 13 % %arrow_forward
- 1. Consider the three stocks in the following table. Pt represents price at time 1, and Q represents shares outstanding at time. Stock C splits two-for-one in the last period. B C PO 81 41 82 00 100 200 200 PI 86 36 92 01 100 200 200 P2 86 36 46 02 100 200 400 a. Calculate the rate of return on a price-weighted index of the three stocks for the first period ( 0 to 1=1). b. What will be the divisor for the price-weighted index in year 2? c. Calculate the rate of return of the price-weighted index for the second period (/= 1 to/= 2). d. Calculate the return on a value-weighted index of the three stocks for the first period (= 0 to 1 = 1).arrow_forwardConsider the following information about two stocks (D and E) and two common risk factors (factor 1 and factor 2) Stock Risk factor 1 Risk factor 2 Expected return (%) D 1.2 3.4 13.1 2.6 2.6 15.4 a. Assuming that the risk free rate is 5%, determine the risk premium for factors 1 and 2 that are consistent with the expected returns for the two stocks. You expect that in one year the prices of Stock D and E will be $55 and $36 respectively and pay no dividends. What should be the price of each stock today to be consistent with the expected return levels. b. C. Determine how to you identified if Stock D and E are overvalued, fairly valued and undervalued? d. Suppose the risk premium for factor 1 as computed in (a) increases by 0.25 percent, what will be the new expected return for D and E? e. Suppose the risk premium for factor 1 as computed in (a) decreases by 0.25%, what will be the new expected return for D and E? f. Devise how would you develop a Jensen Index using Arbitrage Pricing…arrow_forwardConsider the three stocks in the following table. Pt represents price at time t, and ot represents shares outstanding at time t. Stock C splits two for one in the last period. Stock Po A 50 B 45 с 90 120 20 P1 a. Rate of return b. Rate of return 21 60 60 60 120 35 120 95 120 02 60 60 35 120 50 240 P2 Required: Calculate the first-period rates of return on the following indexes of the three stocks (t = 0 to t = 1): Note: Do not round intermediate calculations. Round your answers to 2 decimal places. a. A market-value-weighted index. b. An equally weighted index. % %arrow_forward
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