Question

Given the following information, what is the historical real return for long-term government bonds?

Long-term government	6.40%
Long-term corporate	6.50%
Inflation rate	3.15%

(A) 9.75%

(B) 3.25%

(C) 3.15% (D) -3.36%

Consider the following information about two stocks and indicate which stock has the most systematic risk. State Probability Stock A Stock B Recession   0.15 0.11 (0.35) Norman 0.55 0.18 0.11 Boom 0.30 0.08 0.31 Market risk premium      8.50% Risk-free rate    3.00% (A) Both risk are the same (B) Stock B (C) Stock A (D) Neither stock has any systematic risk

Answer 1

Solution :- 1

As per fisher equation

(1 + R) = (1+r) (1+h)

= (1+R) = ( 1+ 0.064) (1+0.0315)

= (1+R) = (1+0.0975)

= R = 0.0975 = 9.75%

Therefore the correct answer is (A)

Solution 2 :-

State	Probability	Stock A	Stock B	ER(A)	ER(B)
Recession	0.15	0.11	-0.35	0.0165	-0.0525
Normal	0.55	0.18	0.11	0.0990	0.0605
Boom	0.30	0.08	0.31	0.0240	0.0930
	Return of Stocks			0.1395	0.1010
				13.95%	10.10%
Market Risk Premium =		8.50%
Risk Free Rate =		3.00%
As per CAPM equation
Stock A
ER(A)	=	Rf + Beta(Rm-Rf)
13.95%	=	3% + Beta(8.50% - 3%)
10.95%	=	5.5% Beta
Beta	=	10.95/5.5	=	1.99
Stock B
ER(B)	=	Rf + Beta(Rm-Rf)
10.10%	=	3% + Beta(8.50% - 3%)
10.10%	=	5.5% Beta
Beta	=	10.10/5.5	=	1.84
Here the beta of Stock A is higher then beta of Stock B
So Stock A has high systematic risk
Therefore the correct answer is ( C )