Question

We have the following information on Stocks A and B. The risk-free rate is 5%, and the market risk premium is 6.25%. Assume that the market portfolio is correctly priced. Based on the reward-to-risk ratio, are Stocks A and B overpriced, underpriced, or correctly priced?

	Stock A	Stock B
Expected return	10%	15%
Beta	0.8	1.5

Select one:

a. A is underpriced; B is overpriced.

b. A is correctly priced; B is overpriced.

c. A is overpriced; B is underpriced.

d. A is correctly priced; B is underpriced.

e. Both stocks are correctly priced.

2. A portfolio consists of 50% invested in Stock X and 50% invested in Stock Y. We expect two probable states to occur in the future: boom or normal. The probability of each state and the return of each stock in each state are presented in the table below.

State	Probability of state	Return on Stock X	Return on Stock Y
Boom	30%	25%	35%
Normal	70%	10%	5%

What are the expected portfolio return and standard deviation?

Select one:

a. 14.25%; 10.63%

b. 14.25%; 10.31%

c. 18.75%; 11.25%

d. 14.25%; 6.68%

e. 18.75%; 12.12%

3. Given the following information on a portfolio of Stock X and Stock Y, what is the portfolio standard deviation?

• Probability of boom state = 30%
• Probability of normal state = 70%
• Expected return on X = 14.5%
• Expected return on Y = 14%
• Variance on X = 0.004725
• Variance on Y = 0.0189
• Portfolio weight on X = 50%
• Portfolio weight on Y = 50%
• Correlation between X and Y = -1

Select one:

a. 3.44%

b. 10.31%

c. 1.18%

d. 12.86%

e. 6.68%

Answer 1