Question

number 2

Fall 2019 609 1. Consider the following two stocks: Probability Return on Stock A (20%) (9% Recession ) 42% Normal Boom 20% 26% The market risk premium is 10%, and the risk free rate is 4%. a) Which security has more total risk? Return on Stock B -30% 12% 44% b) Which security has more systematic risk? 2. You have $57,000 to invest, and you want to invest in two stocks in such a way that your resulting portfolio has the same level of systematic risk as the market as a whole. You chose invest in Dow Chemical, with a beta of 1.37, and American Express, with a beta of 0.80. How much money should you invest in each stock? 3. Intermountain Resources Inc. has three divisions with the following equity betas: Proportion Division Beta of Assets Lumber 0.7 50% Coal 1.2 30% Tourism 1.3 20% The risk free rate is 7% and the market risk premium is 8%. The firm's debt costs 7.6% per ye tax rate is 25% a) What is Intermountain's cost of equity? b) If the firm uses 40% equity and 60% debt, what is the WACC?

Answer 1

Let the amount invested in Dow = A

Hence amount invested in American Express = 57000-A

Beta of portfolio = 1 which is the weighted beta

Hence

1=1.37*A/57000 +0.8*(57000-A)/57000

57000=1.37A+45600-0.8A

11400=0.57A

A = $20000

Amount invested in Dow= $20000

American Express=$ 37000