Question

Below are returns on the stock A and S&P500 index. All numbers are in decimals (-0.0222 is equivalent to -2.22%).

Stock A S_P500

-0.0222 0.0032

-0.0048 -0.0058

0.1333 0.0434

0.0765 0.1081

-0.0161 -0.0121

0.1250 0.1400

0.0145 0.0368

-0.0475 -0.0454

0.0430 0.0577

-0.0260 -0.1374

0.0071 0.0064

0.0249 0.0186

0.0850 0.0215

-0.0624 -0.0752

0.0933 0.0365

0.0456 0.0528

-0.0632 -0.0131

0.0450 0.0009

0.0200 0.0017

0.0280 0.0985

Suppose that the next S&P500 return will be 7%. Use the CAPM model to calculate the expected return on the stock A. Assume the risk-free rate of 1%.

Provide answer in decimals. For example, 12.34% would be 0.1234.

Also, round your answer to the fourth decimal.

Your Answer:

Answer 1

2	K	L	M	N	O	P	Q
3	Stock A	S_P500			Stock Variance	Covariance	Beta
4	-2.22%	0.32%		Excel Formula	=VAR.S(K4:K23)	=COVARIANCE.S(K4:K23,L4:L23)	= Covariance / Variance
5	-0.48%	-0.58%			0.0033	0.0026	0.7787
6	13.33%	4.34%
7	7.65%	10.81%		S&P500 return (market return) = 7%
8	-1.61%	-1.21%		Risk free rate = 1%
9	12.50%	14.00%		Market premium = Market return - Risk free rate, 7% - 1% = 6%
10	1.45%	3.68%		Beta = 0.7787
11	-4.75%	-4.54%
12	4.30%	5.77%		Cost of equity = Risk free rate + (Beta * Market Premium)
13	-2.60%	-13.74%		1% + (0.7787 * 6%) = 5.6722%
14	0.71%	0.64%
15	2.49%	1.86%		Expected return on the stock A = 0.056722
16	8.50%	2.15%
17	-6.24%	-7.52%
18	9.33%	3.65%
19	4.56%	5.28%
20	-6.32%	-1.31%
21	4.50%	0.09%
22	2.00%	0.17%
23	2.80%	9.85%