Question

owing information whethe vested 40 percent in stock A, 25 percent in State of Probability of Economy State Economy Boom d deviation of a portfolio that is percent in stock Band 15 percent in stock Rate of Return i State Occus Stock Stock 09 16 10 1.1.11 percent b. 289 percent 3.46 percent d. 3.59 percent 401 percent 3. Tom O'Brien has a 2-stock portfolio with a total value of $100,000 $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta! b. c. d. e. 1.17 1.23 1.29 1.35 1.42 5. Cooley Company's stock has a beta of 1.40. the risk-free rate is 4.25%, and the market risk premium is 5.50% What is the firm's required rate of return? a. 11.36% b. 11.65% c. 11.95% d. 12.25% e. 12.55% 7. Porter Ine's stock has an expected retum of 12.25%, a beta of 1.25, and is in equilibrium If the risk-free rate is 5.00%, what is the market risk premium? a. 5.80% b. 5.95% c. 6.09% d. 6.25% c. 6.40% Co. ( 3x)

Answer 1

Answer to Question 4:

Boom:

Expected Return = 0.40 * 0.09 + 0.25 * 0.14 + 0.35 * 0.26
Expected Return = 0.1620

Normal:

Expected Return = 0.40 * 0.16 + 0.25 * 0.10 + 0.35 * 0.12
Expected Return = 0.1310

Expected Return of Portfolio = 0.15 * 0.1620 + 0.85 * 0.1310
Expected Return of Portfolio = 0.13565

Variance = 0.15 * (0.1620 - 0.13565)^2 + 0.85 * (0.1310 - 0.13565)^2
Variance = 0.00012253

Standard Deviation = (0.00012253)^(1/2)
Standard Deviation = 0.0111 or 1.11%

Answer to Question 5:

Weight of Stock A = $37,500 / $100,000
Weight of Stock A = 0.3750

Weight of Stock B = $62,500 / $100,000
Weight of Stock B = 0.6250

Portfolio Beta = Weight of Stock A * Beta of Stock A + Weight of Stock B * Beta of Stock B
Portfolio Beta = 0.3750 * 0.75 + 0.6250 * 1.42
Portfolio Beta = 1.17

Answer to Question 6:

Required Return = Risk-free Rate + Beta * Market Risk Premium
Required Return = 4.25% + 1.40 * 5.50%
Required Return = 11.95%

Answer to Question 7:

Required Return = Risk-free Rate + Beta * Market Risk Premium
0.1225 = 0.05 + 1.25 * Market Risk Premium
0.0725 = 1.25 * Market Risk Premium
Market Risk Premium = 0.0580 or 5.80%