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Assume that the risk-free rate is 5.5% and that the market risk premium is 7%.
a) What is the required rate of return on a stock with a beta of 1.1? Round your answer to two
decimal places.
Use CAPM Formula
Return of asset = risk free return + beta*expected market return
Return of stock = 5.5% + 1.1*7%
=13.20%
b) What is the required rate of return on a stock with a beta of 2.4? Round your answer to two
decimal places.
5.5% + 2.4*7%
=22.30%
c)
What is the required return on the market? Round your answer to two decimal places.
a.
If Stock A's beta were 1.9, then what would be A's new required rate of return? Round your
answer to two decimal places.
Return on stock = 3% + 1.9*(11%-3%) = 18.20%
3. Required Rate of Return
As an equity analyst you are concerned with what will happen to the required return to Universal
Toddler Industries's stock as market conditions change. Suppose r RF = 8%, rM = 12%, and bUTI = 1.5.
What is rUTI, the required rate of return on UTI Stock? Round your answer to two decimal
places.
Now suppose rRF increases to 9%. The slope of the SML remains constant. How would this
affect rM and rUTI?
-Select-
Suppose rRF decreases to 7%. The slope of the SML remains constant. How would this affect
rM and rUTI?
-Select-
d.
Now assume rRF remains at 8% but rM increases to 14%. The slope of the SML does not remain
constant. How would these changes affect r UTI?
-Select-
Assume rRF remains at 8% but rM falls 11%. The slope of the SML does not remain constant.
How would these changes affect rUTI?
-Select-
4. Portfolio Beta
You have a $2 million portfolio consisting of a $100,000 investment in each of 20 different stocks. The
portfolio has a beta of 0.75. You are considering selling $100,000 worth of one stock with a beta of 0.9
and using the proceeds to purchase another stock with a beta of 1.4. What will the portfolio's new
beta be after these transactions? Do not round intermediate calculations. Round your answer to two
decimal places.
beta after disposal
0.75 = 0.9 X 100,000 + B X 1,900,000 / 2,000,000
B = 0.742
and beta after acquiring
B = 0.742 X 1,900,000 + 1.4 X 100,000 / 2,000,000
Beta = 0.775 is the revised beta after the transaction