Question

Consider the following information for three stocks, Stocks A, B, and C. The returns on the three stocks are positively correlated, but they are not perfectly correlated (That is, each of the correlation coefficients is between 0 and 1.) Stock Beta Standard Deviation 14 % A 0.8 Expected Return 9.02% 10.34 12.54 14 1.1 с 14 1.6 Fund P has one-third of its funds vested in each of the three stocks. The risk-free rates 5.5, and the market is in equilibrium (That is required returns equal expected retums.) The data has been collected in the Mcrosoft Exod Online fie below. Open the spreadsheet and perform the required analysis to answer the questions below. Open spreadsheet . What the market risk premium (RF)? Round your answer to two decimal places b. What is the beta of Fund P? Do not found ntermediate calculations. Round your answer to two decimal places. c. What is the required retum of Fund P? Do not found intermediate calculations, Round your answer to two decmal places % d. Would you expect the standard deviation of Fund P to be less than 14%, equal to 14%, or greater than 14%? 1. less than 14% II greater than 14% TIL noual to 14%

Answer 1

Solution:

a)Calculation of market risk premium:

We can calculate the market risk premium using CAPM.As per CAPM,

Expected return=Risk free rate+Beta*Market risk premium

Using value of stock A,market risk premium is;

9.02%=5.5%+0.8*Market risk premium

Market risk premium=3.52/0.8=4.40%

b)Calculation of Beta of fund P

Beta of fund P=Beta of stock*weight of stock

=0.8*1/3+1.1*1/3+1.6*1/3

=1.17

c)Calculation for expected return of fund P

Expected return of fund P=Expected return of stock*weight

=9.02*1/3+10.34*1/3+12.54*1/3

=10.63%

d)Since the market is in equilibrium,hence the standard deviation of fund P shall be equal to 14%