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STOCK AS RETURNS, kA
STOCK BS RETURNS, kB
2003
(18%)
(24%)
2004
44
24
2005
(22)
(4)
2006
22
2007
34
56
a. Calculate the average rate of return for each stock during the 5year period. Assume that someone held a portfolio consisting of 50
percent of Stock A and 50 percent of Stock B. What would have
been the realized rate of return on the portfolio in each year? What
would have been the average re-turn on the portfolio during this
period?
b. Now calculate the standard deviation of returns for each stock
and for the portfolio. Use Equation 6-5.
c. Looking at the annual returns data on the two stocks, would you
guess that the correlation coefficient between returns on the two
stocks is closer to 0.8 or to 0.8?
d. If you added more stocks at random to the portfolio, which of the
following is the most accurate statement of what would happen to
p?
(1) p would remain constant.
(2) p would decline to somewhere in the vicinity of 21 percent.
(3) p would decline to zero if enough stocks were included.
(ST-2) ECRI Corporation is a holding company with four main
subsidiaries. The percentage of its business coming from each of
the subsidiaries, and their respective betas, are as follows:
SUBSIDIARY
PERCENTAGE OF
BUSINESS
BETA
Electric utility
Cable company
Real estate
International/special
projects
60%
25
0.70
0.90
10
5
1.30
1.50
are the only two investments in her portfolio, what is her portfolios
beta?
(6-2) Assume that the risk-free rate is 5 percent and the market risk
premium is 6 percent. What is the expected return for the overall
stock market? What is the required rate of return on a stock that
has a beta of 1.2?
(6-3) Assume that the risk-free rate is 6 percent and the expected
return on the market is 13 percent. What is the required rate of
return on a stock that has a beta of 0.7?
(6-4) A stocks expected return has the following distribution:
RATE OF RETURN
Weak
Below average
Average
Above average
Strong
COMPANYS
PRODUCTS DEMAND
OCCURRING OCCURS
(50%)
(5)
16
25
60
INVESTMENT
$ 400,000
BETA
1.50
600,000
(0.50)
1,000,000
1.25
2,000,000
0.75
If the markets required rate of return is 14 percent and the riskfree rate is 6 percent, what is the funds required rate of return?
(6-10) You have a $2 million portfolio consisting of a $100,000
investment in each of 20 different stocks. The portfolio has a beta
equal to 1.1. You are considering selling $100,000 worth of one
stock that has a beta equal to 0.9 and using the proceeds to
purchase an-other stock that has a beta equal to 1.4. What will be
the new beta of your portfolio following this transaction?
(6-11) Stock R has a beta of 1.5, Stock S has a beta of 0.75, the
expected rate of return on an average stock is 13 percent, and the
risk-free rate of return is 7 percent. By how much does the required
return on the riskier stock exceed the required return on the less
risky stock?
(6-12) Stocks A and B have the following historical returns:
YEAR
STOCK AS RETURNS, kA
STOCK BS RETURNS, kB
1997
(18.00%)
(14.50%)
1998
33.00
21.80
1999
15.00
30.50
2000
(0.50)
(7.60)
2001
27.00
26.30
a. Calculate the average rate of return for each stock during the
period 1997 through
2001.
b. Assume that someone held a portfolio consisting of 50 percent of
Stock A and 50 percent of Stock B. What would have been the
realized rate of return on the portfolio in each year from 1997
through 2001? What would have been the average return on the
portfolio during this period?
c. Calculate the standard deviation of returns for each stock and for
the portfolio.
d. Calculate the coefficient of variation for each stock and for the
portfolio.
e. If you are a risk-averse investor, would you prefer to hold Stock A,
Stock B, or the portfolio? Why?
(6-13) You have observed the following returns over time:
YEAR
STOCK X
STOCK Y
MARKET
1997
14%
13%
12%
1998
19
10
1999
-16
-5
-12
2000
2001
20
11
15
Assume that the risk-free rate is 6 percent and the market risk
premium is 5 percent.
a. What are the betas of Stocks X and Y?
b. What are the required rates of return for Stocks X and Y?
c. What is the required rate of return for a portfolio consisting of 80
percent of Stock X and 20 percent of Stock Y?
d. If Stock Xs expected return is 22 percent, is Stock X under- or
overvalued?
SPREADSHEET PROBLEM
Bartman Industries stock prices and dividends, along with the
Wilshire 5000 Index, are shown below for the period 1995-2000. The
Wilshire 5000 data are adjusted to include dividends.
BARTMAN INDUSTRIES
MARKET INDEX
REYNOLDS INCORPORATED
DIVIDEND
2000
$3.00
$17.250
11,663.98
$1.15
$48.750
1999
14.750
1.06
52.300
2.90
1998
16.500
1.00
48.750
2.75
8,679.98
1997
10.750
0.95
57.250
2.50
6,434.03
1996
11.375
0.90
60.000
2.25
5,602.28
1995
7.625
4,705.97
0.85
55.750
8,785.70
2.00