Question

Can you solve b and c？

HLJP/252Fhewconnect.mheducation.co Saved Consider the following table, which gives a security analyst's expected return on two stocks for two particular market returns: Market Return 56 20 Aggressive Stock 28 32 Defensive Stock 3.58 14 a. What are the betas of the two stocks? (Round your answers to 2 decimal places.) Beta A Beta D 2.00 0.70 es b. What is the expected rate of return on each stock if the market return is equally likely to be 5% or 20%? (Round your answers to 2 decimal places.) Rate of return on A 15.50% 7.00% Rate of return on D

Answer 1

(b.) Calculation of Expected Return if market is equall likely

Expected Return on A = Sum of (Return * Probability)

Equally likely means probability is 50 :50

Expected Return on A = [2% * 0.50] + [32% * 0.50]

= 1% + 16%

= 17%

Expected Return on B = [3.5% * 0.50] + [14% * 0.50]

= 1.75% + 7%

= 8.75%

(c.) Calculation of Alpha of the two stock

Alpha = Actual Expected Return - Required Return

Alpha of A = Actual Expected Return of A - Required Return of A

Actual Expected Return (calculated in part b.)=17%

Required Return = Risk free rate + Beta * (Return from market - Risk Free rate)

Return from market = [5% * 0.50] + [20% * 0.50]

= 2.50% + 10%

= 12.50%

Beta of A (correctly calculated in part a.) = 2

Required Return = 8% + 2 * (12.5%- 8%)

= 8% + 9%

= 17%

Alpha of A = Actual Expected Return of A - Required Return of A

= 17% - 17%

= 0

Alpha of D = Actual Expected Return of D - Required Return of D

Actual Expected Return (calculated in part b.)=8.75%

Required Return = Risk free rate + Beta * (Return from market - Risk Free rate)

Return from market = [5% * 0.50] + [20% * 0.50]

= 2.50% + 10%

= 12.50%

Beta of D (correctly calculated in part a.) = 0.7

Required Return = 8% + 0.7 * (12.5%- 8%)

= 8% + 3.15%

= 11.15%

Alpha of D = Actual Expected Return of D - Required Return of D

= 8.75% - 11.15%

= (-2.4%)