Question

solve without using excel.

show work please.

Beta Expected Return (%) 16.0 12.9 12.2 11.4 11.3 10.1 10.0 9.8 U.S. Steel Disney Ford General Electric Monsanto Boeing Union Pacific Alphabet Exxon Mobil Amazon Intel Pfizer Starbucks IBM McDonald's Coca-Cola Campbell Soup Walmart Newmont Mining PG&E 1.85 1.42 1.31 1.20 1.19 1.01 1.00 0.96 0.94 0.93 0.91 0.90 0.79 0.59 0.51 0.49 0.47 0.26 0.24 0.23 9.6 9.5 9.4 9.3 8.5 7.1 6.6 6.4 6.3 4.8 4.7 4.6

Answer 1

a) The change in Risk free rate from 3% to 6% will pressure market returns to increase. This is because as investors are able to get a higher risk-free return, riskier assets will need to perform better than before in order to meet investors’ new standard for required returns. The investors will perceive other securities as relatively higher risk compared to the risk-free rate. Thus, they will demand a higher rate of return from the market to compensate them for the higher risk.

b) Expected Return on Stocks using assumption in a)

Change in RF rate has led to increase in market returns in same proportion as increase in Risk free rate and Expected Returns have increased in same proportion. Since change in Risk free rate is 3%, market rate is increased to 13% from 10%.

Stock	RF New (Rf)	Beta (B)	Market rate (Rm)	Expected return RE= RF+B(Rm-Rf)
US Steel	6%	1.85	13.0%	19.0%
Disney	6%	1.42	13.0%	15.9%
Ford	6%	1.31	13.0%	15.2%
General Electric	6%	1.2	13.0%	14.4%
Monsanto	6%	1.19	13.0%	14.3%
Boeing	6%	1.01	13.0%	13.1%
Union pacific	6%	1	13.0%	13.0%
Alphabet	6%	0.96	13.0%	12.7%
Exxon Mobil	6%	0.94	13.0%	12.6%
Amazon	6%	0.93	13.0%	12.5%
Intel	6%	0.91	13.0%	12.4%
Pfizer	6%	0.9	13.0%	12.3%
Starbucks	6%	0.79	13.0%	11.5%
IBM	6%	0.59	13.0%	10.1%
Mcdonald's	6%	0.51	13.0%	9.6%
Coca-Cola	6%	0.49	13.0%	9.4%
Campbell Soup	6%	0.47	13.0%	9.3%
Walmart	6%	0.26	13.0%	7.8%
Newmont Mining	6%	0.24	13.0%	7.7%
PG&E	6%	0.23	13.0%	7.6%

c) Expected return if market return remained the same @ 10%.

Stock	RF Old (Rf)	Beta (B)	Market rate (Rm)	Expected return RE= RF+B(Rm-Rf)
US Steel	6%	1.85	10.0%	13.4%
Disney	6%	1.42	10.0%	11.7%
Ford	6%	1.31	10.0%	11.2%
General Electric	6%	1.2	10.0%	10.8%
Monsanto	6%	1.19	10.0%	10.8%
Boeing	6%	1.01	10.0%	10.0%
Union pacific	6%	1	10.0%	10.0%
Alphabet	6%	0.96	10.0%	9.8%
Exxon Mobil	6%	0.94	10.0%	9.8%
Amazon	6%	0.93	10.0%	9.7%
Intel	6%	0.91	10.0%	9.6%
Pfizer	6%	0.9	10.0%	9.6%
Starbucks	6%	0.79	10.0%	9.2%
IBM	6%	0.59	10.0%	8.4%
Mcdonald's	6%	0.51	10.0%	8.0%
Coca-Cola	6%	0.49	10.0%	8.0%
Campbell Soup	6%	0.47	10.0%	7.9%
Walmart	6%	0.26	10.0%	7.0%
Newmont Mining	6%	0.24	10.0%	7.0%
PG&E	6%	0.23	10.0%	6.9%

d) Comparison of returns

Stock	Beta (B)	Expected return with RF =3% (a)	Expected return with RF =6% (b)	Variance (b-a)	Classification of returns under New Rf compared to Old Rf
US Steel	1.85	16.00%	13.4%	-2.600%	Lower returns
Disney	1.42	12.90%	11.7%	-1.220%	Lower returns
Ford	1.31	12.20%	11.2%	-0.960%	Lower returns
General Electric	1.2	11.40%	10.8%	-0.600%	Lower returns
Monsanto	1.19	11.30%	10.8%	-0.540%	Lower returns
Boeing	1.01	10.10%	10.0%	-0.060%	Lower returns
Union pacific	1	10.00%	10.0%	0.000%	Similar returns
Alphabet	0.96	9.80%	9.8%	0.040%	Higher Returns
Exxon Mobil	0.94	9.60%	9.8%	0.160%	Higher Returns
Amazon	0.93	9.50%	9.7%	0.220%	Higher Returns
Intel	0.91	9.40%	9.6%	0.240%	Higher Returns
Pfizer	0.9	9.30%	9.6%	0.300%	Higher Returns
Starbucks	0.79	8.50%	9.2%	0.660%	Higher Returns
IBM	0.59	7.10%	8.4%	1.260%	Higher Returns
Mcdonald's	0.51	6.60%	8.0%	1.440%	Higher Returns
Coca-Cola	0.49	6.40%	8.0%	1.560%	Higher Returns
Campbell Soup	0.47	6.30%	7.9%	1.580%	Higher Returns
Walmart	0.26	4.80%	7.0%	2.240%	Higher Returns
Newmont Mining	0.24	4.70%	7.0%	2.260%	Higher Returns
PG&E	0.23	4.60%	6.9%	2.320%	Higher Returns

If one neglects to adjust the forecast of market return to change in risk free rate, estimates of expected return are likely to be biased. This is because in case of no adjustment to market return, the stocks having beta higher than 1 will produce lower returns invariably and the one with beta less than 1 will produce higher returns and the result hence appears to be biased.

e) Assuming expected rate of return on the market remains at 10%, Walmart would offer higher expected return if the interest rate were 6% rather than 3%. The expected returns will increase to 7% from 4.7%.