Question

In: Finance

You have observed the following returns over time: Assume the risk-free rate is 3.55% and the...

You have observed the following returns over time: Assume the risk-free rate is 3.55% and the market risk premium is 4.60%.
Year Stock A Stock B Market INPUT DATA rRF 3.55% Market Risk Premium 4.60%
1997 14.000% 15.000% 13.143% a. What are the betas of Stocks A and B?
1998 11.000% 9.000% 11.029% bA bB
1999 -2.500% 5.000% 4.109%
2000 14.000% 7.500% 5.097% b. What are the required rates of return for Stocks A and B?
2001 20.000% 13.500% 19.926% rA rB
2002 21.500% 14.000% 24.869%
2003 22.400% 13.500% 21.903% c. What is the required rate of return for a portfolio consisting of 40% A and 60% B?
2004 19.900% 14.400% 15.972% INPUT DATA wA 40.00% rp
2005 21.100% 16.700% 13.006%
2006 24.000% 18.800% 18.937% d. Stock A is trading at a price consistent with the security market line. If your analysis suggests that Stock A will provide a return above the SML, does your analysis suggest that Stock A is undervalued or overvalued? Explain.
2007 26.300% 19.700% 16.960%
2008 25.500% 21.100% 17.949%
2009 22.100% 23.400% 19.926%
2010 13.500% 11.500% 18.937%
2011 6.400% 8.800% 10.040%
2012 -1.100% 4.200% -1.823%
2013 -4.000% 5.600% -1.328%
2014 6.500% 6.800% 5.097%
2015 7.400% 8.700% 10.040%
2016 9.900% 9.900% 13.006%

Solutions

Expert Solution

Year Stock A Stock B Market
1997 14.00% 15.00% 13.14%
1998 11.00% 9.00% 11.03%
1999 -2.50% 5.00% 4.11%
2000 14.00% 7.50% 5.10%
2001 20.00% 13.50% 19.93%
2002 21.50% 14.00% 24.87%
2003 22.40% 13.50% 21.90%
2004 19.90% 14.40% 15.97%
2005 21.10% 16.70% 13.01%
2006 24.00% 18.80% 18.94%
2007 26.30% 19.70% 16.96%
2008 25.50% 21.10% 17.95%
2009 22.10% 23.40% 19.93%
2010 13.50% 11.50% 18.94%
2011 6.40% 8.80% 10.04%
2012 -1.10% 4.20% -1.82%
2013 -4.00% 5.60% -1.33%
2014 6.50% 6.80% 5.10%
2015 7.40% 8.70% 10.04%
2016 9.90% 9.90% 13.01% Using SLOPE function of excel with StockA Return as Y axis and Market Return as X axis:
Beta of StockA 1.083722
Using SLOPE function of excel with Stock B Return as Y axis and Market Return as X axis:
Beta of StockB 0.570676
Required Return of StockA
3.55+1.083722*4.6= 8.535121 Percent 8.54%
Required Return of StockB
3.55+0.570676*4.6= 6.175108 percent 6.18%
Required Return of Portfolio:
0.4*Return of A +0.6* Return of B
0.4*8.535121+0.6*6.175108= 7.119113 Percent 7.12%
If Stock A will provide return higher than SML, it is undervalued



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