CHAPTER 6 RISK AND RATE OF RETURN

STUDY PROBLEM (SET A)

6-3A. (Expected rate of return and risk) Pritchard Press, Inc., is evaluating a
security. One-year Treasury bills are currently paying 3.1 percent. Calculate
the following investment’s expected return and its standard deviation. Should
Pritchard invest in this security?

PROBABILITY RETURN

.15 -1%

.30 2%

.40 3%

.15 8%

Answer:

6-4A. (Expected rate of return and risk) Syntex, Inc., is considering an investment
in one of two common stocks. Give the information that follows, which
investment is better, base on risk (as measured by the standard deviation)
and return?

COMMON STOCK A COMMON STOCK

B

PROBABILITY RETURN PROBABILITY

RETURN

.30 11% .20 -5%

.40 15% .30 6%

.30 19% .30 14%

.20 22%

Answer:
6-5A. (Expected rate of return and risk) Fridman Manufacturing, Inc., has prepared
the following information regarding two investment under consideration.
Which investment should be accepted?

COMMON STOCK A COMMON STOCK

B

PROBABILITY RETURN PROBABILITY

RETURN

.20 -2% .10 4%

.50 18% .30 6%

.30 27% .40 10%

.20 15%

Answer:

6-8A. (Capital asset pricing model) Johnson Manufacturing, Inc., in considering

several investment. The rate on Treasury bills is currently 6.75 percent, and
the expected return for the market is 12 percent. What should be the
required rates of return for each investment (using the CAMP)?

SECURITY BETA

A 1.50

B .82

C .60

D 1.15

Answer:

6-13A. (Portfolio beta and security market line) You own a portfolio consisting
of the following stocks:
 PERCENTAGE EXPECTED
STOCK OF PORTFOLIO BETA
RETURN

1 20% 1.00 16%

2 30% 0.85 14%

3 15% 1.20 20%

4 25% 0.60 12%

5 10% 1.60 24%

The risk-free rate is 7 percent. Also, the expected return on the market
portfolio is 15.5 percent.

a. Calculate the expected return of your portfolio. (Hint: The expected return
of a portfolio equal the weighted average of the individual stock’s
expected return, where the weight are percentage invested in each
stock.)

b. Calculate the portfolio beta.

c. Given the information preceding, plot the security market line on paper.
Plot the stocks from your portfolio on your graph.

d. From your plot in part (c), which stock appear to be your winners and
which one appear to be losers?

e. Why should you consider your conclusion in part (d) to be less than
certain?

Answer

6-18A. (Required rate of return using CAPM) Whitney common stock has a
beta of 1.2. The expected rate of return for the market is 9 percent and the
risk-free rate is 5 percent.

a. Compute a fair rate of return based on this information.

b. What would be a fair rate if the beta were .85?

c. What would be the effect on the fair rate if the expected return for the
market improved to 12 percent?
Answer:

CHAPTER 7 VALUATION AN CHARACTERISTIC OF BONDS

STUDY PROBLEM (SET A)

7-2A. (Bond valuation) Enterprise, Inc., bonds have a 9 percent coupon rate. The
interest is paid semiannually and the bonds mature in eight years. There par
value is $1,000. If you required rate of return is 8 percent, what is the value
of the bond? What is its value if the interest is paid annually?

Answer:

7-6A. (Bond valuation) Waco Industries 15-year, $1,000 par value bonds pay 8
percent interest annually. The market price of the bonds is $1,085, and your
required rate of return is 10 percent.

a. Compute the bond’s expected rate of return.

b. Determine the value of the bond to you, give your required rate of return.

c. Should you purchase the bond?

Answer:

7-14A. (Bond valuation) Stanley, Inc., issues 15-year $1,000 bonds that pay
$85 annually. The market price for the bonds is $960. You required rate of
return is 9 percent.

a. What the value of the bond to you?

b. What happens to the value if you required rate of return (i) increases to
11 percent or (ii) decreases to 7 percent?

c. Under which of the circumstances in part (b) should you purchase the
bond?
Answer:

STUDY PROBLEM (SET B)

7-9B. (Bond valuation) Visador Corporation Bond pay $70 in annual interest, with a
$1,000 par value. The bonds mature in 17 years. You required rate of return
is 8.5 percent.

a. Calculate the value of the bond.

b. How does the value change if you required rate of return (k) (i) increases
to 11 percent or (ii) decreases to 6 percent?

c. Interpret your finding in part (a) and (b).

Answer:

7-11B. Carl Corporation four-year $1,000 par bonds pay 12 percent interest.
You required rate of return 9 percent. The current market price for the bond
is $1,350.

a. Determine the expected rate of return.

b. What is the value of the bond to you given your required rate of return?

c. Should you purchase the bond at the current market price?

Answer: