Question

Consider the following two scenarios for the economy and the expected returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D. Scenario Bust Boom Rate of Return Aggressive Defensive Market Stock A Stock D -12% -4% 15 -6% 36 10 Required: a. Find the beta of each stock. b. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock. c. If the T-bill rate is 5%, what does the CAPM say about the fair expected rate of return on the two stocks? d. Which stock seems to be a better buy on the basis of your answers to (a) through (c)? Complete this question by entering your answers in the tabs below. Required A Required B Required C Required D Find the beta of each stock. (Round your answers to 2 decimal places.) Beta Stock A Stock D

Answer 1

Solution: Beta=Difference in stock return-difference in market return Stock A Stock D (0.36-(-0.12))/(0.15-(-0.06) (0.10-(-0,04))/(0.15-(-0.06)) 2.29 0.67 b) Expected return Market portfolio Stock A Stock D - 0.12*0.5*0.36*0.5 -0.06*0.5+0.15*0.5 -0.12*0.5+0.36*0.5 -0.04*0.5+0.10*0.5 4.50% 12.00% 3.00% Expected return=risk free rate+beta*(market return-risk free rate) Stock A Stock D 0.05+2.29* (0.045-0.05) 0.05+0.67*(0.045-0.05) 3.86% 4.67% Stock A better buy (as it outperforms market return)