Question

Use the following information to evaluate whether or not you should buy stock A.

                           Stock A                                                                      S&P 500

              Probability                       Return                              Probability         Return

                  0.1                                   -100%                                 0.3                      -30%

                  0.2                                    -10%                                  0.4 15%

                  0.6                                    18%                                  0.3 40%

                  0.1                                   130%

The current yield on the 10-year Treasury Note (risk-free rate) is 3.3%. The correlation between Stock A and the market is 0.53.

Hint One – Remember that the S&P 500 represents the market and that you can use the two probability distributions above to get the expected return and standard deviation for both Stock A and for the market (round calculations to 2 decimal places in percentage terms).

Hint Two – You will use the SML to get the required return and you will need to calculate beta from the data provided (round beta to two decimal places).

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -