Question

The stock of Jones Trucking is expected to return 15 percent annually with a standard deviation of 7 percent. The stock of Bush Steel Mills is expected to return 19 percent annually with a standard deviation of 10 percent. The correlation between the returns from the two securities has been estimated to be +0.3. The beta of the Jones stock is 1.2, and the beta of the Bush stock is 1.5. The risk-free rate of return is expected to be 6 percent, and the expected return on the market portfolio is 14 percent. The current dividend for Jones is $4. The current dividend for Bush is $6.

What is the expected return from a portfolio containing the two securities if 30 percent of your wealth is invested in Jones and 70 percent is invested in Bush? Round your answer to one decimal place.

%

What is the expected standard deviation of the portfolio of the two stocks? Round your answer to two decimal places.

%

Which stock is the better buy in the current market? Round your answers to one decimal place.

Required return (Jones):  %

Required return (Bush):  % The -(Jones or Bush) stock is the better buy because the expected return is (lower or higher) than the required return.

Answer 1

1.Expected return of Portfolio = Weight of Jones Trucking * Expected return of Jones Trucking + Weight of Bush Steel Mills * Expecetd return of Bush Steel Mills = 0.3 *15% + 0.7 * 19% = 17.8%

2. Standard deviation = [( Weight of Jones Trucking * Standard Deviation of Jones Trucking)²+ (Weight of Bush Steel Mills * Standard Deiation of Bush Steel Mills)² + 2* Weight of Jones Trucking * Standard Deviation of Jones Trucking*Weight of Bush Steel Mills * Standard Deiation of Bush Steel Mills* Correlation]^1/2
=[ (0.3*0.07)² + (0.7 * 0.1)² + 2* 0.3 * 0.07 * 0.7 * 0.1 * 0.3]^1/2 = 7.89%

3.According to Capm Required return of Jones Trucking = Risk Free Rate + Beta * ( Market Return - Risk Free Rate) = 6% + 1.2 * ( 14% -6%) =15.6%

4. According to Capm Required return of Bush Steel Mills = Risk Free Rate + Beta * ( Market Return - Risk Free Rate) = 6% + 1.5 * ( 14% -6%) =18%

5.The ( Bush) stock is the better buy because the expected return is ( higher) than the required return
Expected return =19% and required rate = 18%

Best of Luck. God Bless