Foundations Of Finance
10th Edition
ISBN: 9780134897264
Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher: Pearson,
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Chapter 6, Problem 4SP
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(Expected rate of return and risk) Syntex, Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on
the risk (as measured by the standard deviation) and return?
Common Stock A
Probability
0.25
0,50
0.25
Probability
0.10
0.40
0.40
0.10
(Click on the icon in order to copy its contents into a apreadsheet)
Common Stock B
Return
10%
17%
18%
Return
-4%
7%
13%
20%
G
a. Given the information in the table, the expected rate of return for stock A is 15.5% (Round to two decimal places)
The standard deviation of stock A is
(Round to two decimal places.)
(Expected rate of return and risk) Syntex, Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on the risk (as
measured by the standard deviation) and return?
Common Stock A
Probability
0.20
0.60
0.20
Probability
0.15
0.35
0.35
0.15
(Click on the icon in order to copy its contents into a spreadsheet.)
Common Stock B
Return
13%
14%
18%
Return
- 6%
7%
15%
21%
a. Given the information in the table, the expected rate of return for stock A is 14.6 %. (Round to two decimal places.)
The standard deviation of stock A is %. (Round to two decimal places.)
When working with the CAPM, which of the following factors can be determined with the most precision?
a. The beta coefficient of "the market," which is the same as the beta of an average stock.
b. The beta coefficient, bi, of a relatively safe stock.
c. The market risk premium (RPM).
d. The most appropriate risk-free rate, rRF.
e. The expected rate of return on the market, rM.
Chapter 6 Solutions
Foundations Of Finance
Ch. 6 - a. What is meant by the investors required rate of...Ch. 6 - Prob. 2RQCh. 6 - What is a beta? How is it used to calculate r, the...Ch. 6 - Prob. 4RQCh. 6 - Prob. 5RQCh. 6 - Prob. 6RQCh. 6 - Prob. 7RQCh. 6 - What effect will diversifying your portfolio have...Ch. 6 - (Expected return and risk) Universal Corporation...Ch. 6 - (Average expected return and risk) Given the...
Ch. 6 - (Expected rate of return and risk) Carter, Inc. is...Ch. 6 - (Expected rate of return and risk) Summerville,...Ch. 6 - Prob. 5SPCh. 6 - Prob. 9SPCh. 6 - Prob. 10SPCh. 6 - Prob. 11SPCh. 6 - Prob. 12SPCh. 6 - Prob. 14SPCh. 6 - (Capital asset pricing model) Using the CAPM,...Ch. 6 - Prob. 16SPCh. 6 - Prob. 17SPCh. 6 - a. Compute an appropriate rate of return for Intel...Ch. 6 - (Estimating beta) From the graph in the right...Ch. 6 - Prob. 20SPCh. 6 - Prob. 21SPCh. 6 - (Capital asset pricing model) The expected return...Ch. 6 - (Portfolio beta and security market line) You own...Ch. 6 - (Portfolio beta) Assume you have the following...Ch. 6 - Prob. 1MCCh. 6 - Prob. 2MCCh. 6 - Prob. 3MCCh. 6 - Prob. 4MCCh. 6 - Prob. 5MCCh. 6 - Prob. 6MCCh. 6 - Prob. 7MCCh. 6 - Prob. 8MCCh. 6 - Prob. 9MCCh. 6 - Prob. 10MCCh. 6 - Prob. 11MC
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- Calculate the correlation coefficient between Blandy and the market. Use this and the previously calculated (or given) standard deviations of Blandy and the market to estimate Blandy’s beta. Does Blandy contribute more or less risk to a well-diversified portfolio than does the average stock? Use the SML to estimate Blandy’s required return.arrow_forwarda. Determine Stock X's beta coefficient. b. Determine the arithmetic average rates of return for Stock X and the NYSE over the period given. Calculate the standard deviations of returns for both Stock X and the NYSE. c. Assume that the required return on equity, re, for Stock X is equal to its average return. Likewise, assume that the market return is equal to the NYSE's average return. Using the information calculated, what is the assumed risk-free rate in the CAPM equation? Hint: Solve algebraically for rf in, re = r¡ + B(rm – r;)arrow_forwardSyntex, Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on the risk (as measured by the standard deviation) and return? Common Stock A Common Stock B Probability Return Probability Return 0.25 13% 0.25 −7% 0.50 14% 0.25 7% 0.25 18% 0.25 16% 0.25 23% (Click on the icon in order to copy its contents into a spreadsheet.) Question content area bottom Part 1 a. Given the information in the table, the expected rate of return for stock A is enter your response here %. (Round to two decimal places.) Part 2 The standard deviation of stock A is enter your response here %. (Round to two decimal places.) Part 3 b. The expected rate of return for stock B is enter your response here %. (Round to two decimal places.) Part 4 The standard deviation for stock B is enter…arrow_forward
- Syntex, Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on the risk (as measured by the standard deviation) and return? Common Stock A Common Stock B Probability Return Probability Return 0.35 13% 0.25 −7% 0.30 17% 0.25 8% 0.35 21% 0.25 15% 0.25 23% (Click on the icon in order to copy its contents into a spreadsheet.) Question content area bottom Part 1 a. Given the information in the table, the expected rate of return for stock A is enter your response here%. (Round to two decimal places.)arrow_forwardConsider the stocks in the table with their respective beta coefficients to answer the following questions:a. Which of the assets represents the most sensitive to fluctuations or changes in market returns and why? What impact in terms of risk and return would this asset have if you add it to an investment portfolio in a higher proportion than all other assets? b. Which of the assets represents the least sensitive to fluctuations or changes in market returns and why? What impact in terms of risk and return would this asset have, if you add it to an investment portfolio in a greater proportion than all other assets? Stock Beta SKT 0.65 COST 0.90 SU 1.42 AMZN 1.57 V 0.94arrow_forwardQUESTIONS: 1) Assuming that the risk-free rate of return is currently 3,2%, the market risk premium is 6% whereas the beta of HelloFresh SH. stock is 1.8, compute the required rate of return using CAPM. 2) Compute the value of each investment based on your required rate of return and interpret the results comparing with the market values. 3) Which investment would you select? Explain why using appropriate financial jargon (language). 4) Assume HelloFresh SH's CFO Mr. Christian Gaertner expects an earnings upturn resulting increase in growth (rate) of 1%. How does this affect your answers to Question 2 and 3? 5) AACSB Critical Thinking Questions: A) Companies pay rating agencies such as Moody's and S&P to rate their bonds, and the costs can be substantial. However, companies are not required to have their bonds rated in the first place; doing so is strictly voluntary. Why do you think they do it? (Textbook page: 198) B) What are the difficulties in using the PE ratio to value stock?…arrow_forward
- d. Interpret your results in (c) above, assuming that the historical average return of 8.5% from the stock is a good benchmark. e. Critically evaluate the strengths and weaknesses of applying the implied rate of return from the RIVM as a proxy of the expected return.arrow_forwardConsider the following information about the various states of the economy and the returns of various investment alternatives for each scenario. Answer the questions that follow. Question 1 Fill in the parts in the above table that are empty. Using the data generated in the previous question (Question 1); Plot the Security Market Line (SML) 2. Superimpose the CAPM’s required return on the SML % Return on T-Bills, Stocks, and Market Index State of the Economy Probability T- Bills Phillips Pay- up Rubber- made Market Index Recession 0.2 7 -22 28 10 -13 Below Average 0.1 7 -2 14.7 -10 1 Average 0.3 7 20 0 7 15 Above Average 0.3 7 35 -10 45 29 Boom 0.1 7 50 -20 30 43 Mean Standard Deviation Coefficient of Variation Covariance with MP…arrow_forwardAttached imagearrow_forward
- Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset's expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence. Consider the following case: Ethan owns a two-stock portfolio that invests in Falcon Freight Company (FF) and Pheasant Pharmaceuticals (PP). Three-quarters of Ethan's portfolio value consists of FF's shares, and the balance consists of PP's shares. Each stock's expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table: Market Condition Strong Normal Probability of Occurrence 0.50 0.25 Falcon Freight Pheasant Pharmaceuticals 27.5% 38.5% 16.5% 22% Weak 0.25 -22% -27.5% Calculate expected…arrow_forwardAssume you wish to evaluate the risk and return behaviors associated with various combinations of two stocks, Alpha Software and Beta Electronics, under three possible degrees of correlation: perfect positive, uncorrelated, and perfect negative. The average return and standard deviation for each stock appears here: a. If the returns of assets Alpha and Beta are perfectly positively correlated (correlation coefficient = + 1), over what range would the average return on portfolios of these stocks vary? In other words, what is the highest and lowest average return that different combinations of these stocks could achieve? What is the minimum and maximum standard deviation that portfolios Alpha and Beta could achieve? b. If the returns of assets Alpha and Beta are uncorrelated (correlation coefficient = 0), over what range would the average return on portfolios of these stocks vary? What is the standard deviation of a portfolio that invests 75% in Alpha and 25% in Beta? How does this…arrow_forwarda) Consider two assets with the following characteristics: Expected return of asset 1 = 0.15, Standard deviation of asset 1 = 0.10, portion in asset 1 = 0.5 Expected return of asset 2 = 0.20, Standard deviation of asset 2 = 0.20, Compute the expected return and standard deviation of portfolio if correlation coefficient (r1,2) = 0.40 and (r1,2)= -0.60 b) Why do most investors hold diversified portfolio?arrow_forward
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