Question
In: Finance
Consider the following situation: State of Economy Probability of State of Economy Returns if State Occurs...
Consider the following situation:
|
State of Economy |
Probability of State of Economy |
Returns if State Occurs |
||
|
Stock A |
Stock B |
Stock C |
||
|
Boom |
20% |
25% |
10% |
5% |
|
Recession |
80% |
-30% |
5% |
10% |
The expected return on the market portfolio is 7% and the US Treasury bill yields 3%. The capital market is currently in equilibrium.
Show your work. Do not use excel.
- (5 points) Which stock has the most systematic risk? Provide all the steps and equations.
- (5 points) Which stock has the most unsystematic risk? Explain why. Provide all the steps and equations.
- (10 points) What is the standard deviation of a portfolio which is comprised of $8,400 invested in stock A, $3,600 in stock B, and $8,000 in stock C?
- (5 points) If the expected inflation rate is 2.5%, what is the exact expected real return on the portfolio of part (c)?
Solutions
Expert Solution
| a) Systematic Risk = Beta | |||||||
| Returns if State Occurs | Expected Return | ||||||
| State of Economy | Probability of State of Economy | Stock A | Stock B | Stock C | Prob. x Stock A 's Return | Prob. x Stock A 's Return | Prob. x Stock A 's Return |
| Boom | 20.00% | 25.00% | 10.00% | 5.00% | 5.00% | 2.00% | 1.00% |
| Recession | 80.00% | -30.00% | 5.00% | 10.00% | -24.00% | 4.00% | 8.00% |
| Total | -19.00% | 6.00% | 9.00% | ||||
| According CAPM Expected Return E(R)= Risk free Rate + Beta x (Market Return - Risk free Rate) | |||||||
| Risk Free Rate RF = | 3.00% | ||||||
| Return on market RM | 7.00% | ||||||
| Stock A 's Beta = -19% - 3% = Beta x (7% -3%) | -5.5 | ||||||
| Stock B 's Beta = 6% - 3% = Beta x (7% -3%) | 0.75 | ||||||
| Stock C 's Beta = 9% - 3% = Beta x (7% -3%) | 1.5 | ||||||
| Stock C has the most systematic risk because it has the highest beta. | |||||||
| b) | |||||||
| Stock A has the most unsystematic risk because it has the negative Beta. |
jeff jeffy answered 1 year agoRelated Solutions
Consider the following situation: State of Economy Probability of State of Economy Returns if State Occurs...
Consider the following situation:
State of Economy
Probability of State of Economy
Returns if State Occurs
Stock A
Stock B
Stock C
Boom
20%
25%
10%
5%
Recession
80%
-30%
5%
10%
The expected return on the market
portfolio is 7% and the US Treasury bill yields 3%. The capital
market is currently in equilibrium.
Which stock has the most systematic risk? Provide all the steps
and equations.
Which stock has the most unsystematic risk? Explain why.
Provide all the...
Consider the following situation: State of Economy Probability of State of Economy Returns if State Occurs...
Consider the following situation:
State of Economy
Probability of State of Economy
Returns if State Occurs
Stock A
Stock B
Stock C
Boom
20%
25%
10%
5%
Recession
80%
-30%
5%
10%
The expected return on the market
portfolio is 7% and the US Treasury bill yields 3%. The capital
market is currently in equilibrium.
(5 points) Which stock has the most systematic risk? Provide
all the steps and equations.
(5 points) Which stock has the most unsystematic risk? Explain...
Consider the following situation: State of Economy Probability of State of Economy Returns if State Occurs...
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The capital market is currently in equilibrium.
(a) (5 points) Which stock has the most systematic risk? Provide
all the steps and equations.
(b) (5 points) Which stock has the most unsystematic...
) Consider the following situation: State of Economy Probability of State of Economy Returns if State...
) Consider the following situation:
State of Economy
Probability of State of Economy
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Stock B
Stock C
Boom
20%
25%
10%
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Recession
80%
-30%
5%
10%
The expected return on the market
portfolio is 7% and the US Treasury bill yields 3%. The capital
market is currently in equilibrium.
(5 points) Which stock has the most systematic risk? Provide
all the steps and equations.
(5 points) Which stock has the most unsystematic risk?...
Suppose you observe the following situation: State of Economy Probability of State Return if State Occurs...
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Probability
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Return if State Occurs
Stock A
Stock B
Bust
.15
−.08
−.10
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.60
.11
.09
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a.
Calculate the expected return on each stock.
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8
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Consider the following information: Rate of Return if State Occurs State of Economy Probability of...
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State of Economy
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Stock A
Stock B
Stock C
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Requirement
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What is the expected return on an equally weighted portfolio of
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