Question

can you olease do it it corporate finance and please explain

The table below provides the beta and expected return for five stocks. All of these stocks but one lie on the Security Market Line. Determine the alpha of the stock that does not lie on the Security Market Line. Stock 1 Stock 2 Stock 3 Stock 4 Stock 5 Beta 0.3 0.5 0.7 1.0 1.3 Expected 5.11% 9.26% 8.99% 11.9% 14.81% Return 02.03% O 2.39% 1.68% O 2.21% O 1.86%

Answer 1

d.2.21%.

first let us calculate the market premium, using stock with beta 1.0.. i.e stock 4.

now,

consider stock 5 and stock 4.

differences in expected returns / difference in beta

=> (14.81-11.9) / (1.30-1.00)

=>9.70%.

now,

consider stock 4 and stock 3.

=> (11.9-8.99) / (1.0-0.70)

=>9.70%

consider stock 4 and stock 2

=> (11.9-9.26) /(1.0-0.50)

=>5.28%.

since this is not equal to 9.70% as obtained in above two cases, it can be said that stock 2 is not on sml.

now,

let us calculate the risk free rate

return on stock with beta 1.0 - market premium

=>11.9 - 9.7

=>2.20%.

now.

return on stock 2 as per capm shall be:

risk free rate + beta* (market premium)

=>2.20%+0.50*(9.70%)

=>7.05%.

Alpha of the stock = capm return - expected return

=>7.05%- 9.26%

=>2.21%.