Question

ou have observed the following returns over time:

Year	Stock X		Stock Y		Market
2014	13	%	13	%	14	%
2015	20		5		9
2016	-16		-2		-12
2017	3		3		3
2018	24		12		16

Assume that the risk-free rate is 7% and the market risk premium is 5%.

1. What are the betas of Stocks X and Y? Do not round intermediate calculations. Round your answers to two decimal places.

   Stock X:

   Stock Y:

2. What are the required rates of return on Stocks X and Y? Do not round intermediate calculations. Round your answers to two decimal places.

   Stock X:   %

   Stock Y:   %

3. What is the required rate of return on a portfolio consisting of 80% of Stock X and 20% of Stock Y? Do not round intermediate calculations. Round your answer to two decimal places.

     %

Answer 1

	Given,
	Year	Return on stock X (Rx)	Return on stock Y (Ry)	Return on market (Rm)
	2014	13%	13%	14%
	2015	20%	5%	9%
	2016	-16%	-2%	-12%
	2017	3%	3%	3%
	2018	24%	12%	16%
	Rf=7%
	Market Risk premium=5%
a)	Calculation of Betas
	We know beta of stock= (Expected return on stock-Rf)/(Expected return from market-Rf)
	Betas of stock X
	2014	=(13-7)/(14-7)	0.86
	2015	=(20-7)/(9-7)	6.50
	2016	=(-16-7)/(-12-7)	1.21
	2017	=(3-7)/(3-7)	1.00
	2018	=(24-7)/(16-7)	1.89
	Betas of stock Y
	2014	=(13-7)/(14-7)	0.86
	2015	=(5-7)/(9-7)	-1.00
	2016	=(-2-7)/(-12-7)	0.47
	2017	=(3-7)/(3-7)	1.00
	2018	=(12-7)/(16-7)	0.56
b)	Calculation of rate of return on stocks
	As per CAPM,
	Required return= Rf+Market risk premium*Beta
	Rate of return on stock X
	2014	=7+5*0.86	11.30%
	2015	=7+5*6.50	39.50%
	2016	=7+5*1.21	13.05%
	2017	=7+5*1	12.00%
	2018	=7+5*1.89	16.45%
	Rate of return on stock Y
	2014	=7+5*0.86	11.30%
	2015	=7+5*-1	2.00%
	2016	=7+5*0.47	9.35%
	2017	=7+5*1	12.00%
	2018	=7+5*0.56	9.80%
c)	Required return on portfolio
	Year	Return on stock X (Rx)	Weight of X (Wx)	Rx*Wx	Return on stock Y (Ry)	Weight of X (Wy)	Ry*Wy	Expected return on portfolio
	2014	13%	0.80	10.40%	13%	0.20	2.60%	=10.40+2.60	13.00%
	2015	20%	0.80	16.00%	5%	0.20	1.00%	=16+1	17.00%
	2016	-16%	0.80	-12.80%	-2%	0.20	-0.40%	-12.80-0.40	-13.20%
	2017	3%	0.80	2.40%	3%	0.20	0.60%	=2.40+0.60	3.00%
	2018	24%	0.80	19.20%	12%	0.20	2.40%	=19.20+2.40	21.60%
		Expected return of portfolio= Weighted average (See table above)