Question

15% 0% TU) You are given Tollowing intornation: Market Scenario Probability cp) Stock As Returns Stock Bs Returns Market In

0 0
Add a comment Improve this question Transcribed image text
Answer #1

a) The expected return of a security is calculated from the following formula:

Expected return = p1*r1 + p2*r2 + ........pn*rn

Where, r is the expected return in a given scenario

p is the probability of return in a given scenario

Therefore, Expected return of stock A = 0.1*25 +0.2*18 + 0.3*10 +0.2*0 + 0.2*(-8)

= 7.5%

Expected return of stock B = 0.1*0 + 0.2*4 +0.3*8 + 0.2*12 + 0.2*16

= 8.8%

Expected return of market index = 0.1*15 + 0.2*10 + 0.3*6 + 0.2*0 + 0.2*(-4)

= 4.5%

b) Expected return on portfolio= (Return on Stock A * Weight of stock A) + (Return on Stock B* Weight of Stock B)

Weight of stock is calculated as stock value/Total investment

Expected return on portfolio = 7.5 *(3000/8000) + 8.8*(5000/8000)

= 8.3125 %

Standard deviation of portfolio is calculated as

Op = wi* oỉ + wź * oỉ +2* W1 * W2 * Cov1,2

Where, w1 is weight of stock 1

w2 is weight of stock 2

\sigma _{1} is standard deviation of stock 1

\sigma _{2} is standard deviation of stock 2

\sigma _{p} is standard deviation of portfolio

Weight of stock A = 3000/8000 = 0.375

Weight of stock B = 5000/8000 = 0.625

Therefore standard deviation of portfolio AB =

(0.3752 +0.10672 + 0.62.5 +0.05 +2+ 10.375+10.525+(-10.0053 2015

= 0.94%

c) Beta of stock = E(rx)-rf / E(rm) - rf

Where, E(rx) is expected return of stock x

rf is risk free rate

E(rm) is expected return of market

Beta of stock A = 7.5-2 / 4.5-2

= 2.2

Beta of stock B = 8.8-2 / 4.5-2

= 2.72

d). Required return if CAPM holds = rf + Beta*(rm - rf)

Required return of stock A = 2 + 2.2*(4.5-2) = 7.5%

Stock A is correctly priced since its required return equals expected return

Required return of stock B = 2 + 2.72*(4.5-2) = 8.8%

Stock B is also correctly priced since its required return equals expected return

Add a comment
Know the answer?
Add Answer to:
15% 0% TU) You are given Tollowing intornation: Market Scenario Probability cp) Stock A's Returns Stock...
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for? Ask your own homework help question. Our experts will answer your question WITHIN MINUTES for Free.
Similar Homework Help Questions
ADVERTISEMENT
Free Homework Help App
Download From Google Play
Scan Your Homework
to Get Instant Free Answers
Need Online Homework Help?
Ask a Question
Get Answers For Free
Most questions answered within 3 hours.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT