Consider the following table, which gives a security analyst’s expected return on two stocks in two particular scenarios for the rate of return on the market.

Consider the following table, which gives a security analyst’s expected return on two stocks in two particular scenarios for the rate of return on the market. Assume that both scenarios are equally likely to happen (i.e., probability of scenario 1 = probability of scenario 2=0.5).

Scenarios	Market Return	Aggressive Stock	Defensive Stock
1	5%	−2%	6%
2	25 %	38%	12%

What are the betas of the two stocks?
Plot the two securities on the SML graph. Assume that T-bill rate is 6%.
What are the alphas of each?

Solutions

Expert Solution

Q3)

beta = change in security return / change in market return

Aggressive stock:

Beta = (38% - (-2%)) / (25% - 5%) = 2

Defensive stock:

Beta = (12% - 6%) / (25% - 5%) = 0.3

Expected return on market = (0.5*5%) + (0.5*25%) = 15%

given risk free rate = 6%

As per CAPM requird return = Rf + beta*(Rm - Rf)

Rf = risk free rate

Rm = market return

SML return of aggressive stock = 6% + 2*(15% - 6%) = 24%

SML return of Defensive stock = 6% + 0.3*(15% - 6%) = 8.7%

Graph:

Expecetd return on aggressive stock = (0.5*(-2%)) + (0.5*38%) = 18%

Expected return on defesive stock = (0.5*6%) + (0.5*12%) = 9%

Alpha = expected return - SML return

Alpha Aggressive = 18% - 24% = -6%

Alpha Defensive = 9% - 8.7% = 0.3%

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

Consider the following table, which gives a security analyst's expected return on two stocks In two particular scenarios for the rate of return on the market:

Problem 9-9 Consider the following table, which gives a security analyst's expected return on two stocks In two particular scenarios for the rate of return on the market: Market Return Aggressive Stock Defensive Stock 7% -4% 4%253513Aggressive Stock Market Return 7% Defensive Stock -4% 25 13 a. What are the betas of the two stocks? b. What is the expected rate of return on each stock if the two scenarios for the market return are equally likely to be 7% or 25%? e. What hurdle rate...

Consider the following table, which gives a security analyst’s expected return on two stocks in two...

Consider the following table, which gives a security analyst’s expected return on two stocks in two particular scenarios for the rate of return on the market: Market Return Aggressive Stock Defensive Stock 5 % –3 % 4 % 24 36 9 a. What are the betas of the two stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Agressive stock: Defensive stock b. What is the expected rate of return on each stock if the two...

Consider the following table, which gives a security analyst’s expected return on two stocks in two...

Consider the following table, which gives a security analyst’s expected return on two stocks in two particular scenarios for the rate of return on the market: Market Return Aggressive Stock Defensive Stock 6 % –4 % 3 % 21 34 9 a. What are the betas of the two stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Beta Aggressive stock Defensive stock b. What is the expected rate of return on each stock if the...

Consider the following table, which gives a security analyst’s expected return on two stocks in two...

Consider the following table, which gives a security analyst’s expected return on two stocks in two particular scenarios for the rate of return on the market: Market Return Aggressive Stock Defensive Stock 6 % –4 % 3 % 21 34 9 a. What are the betas of the two stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Beta Aggressive Stock Defensive Stock b. What is the expected rate of return on each stock if the...

Problem 9-9 Consider the following table, which gives a security analyst’s expected return on two stocks...

Problem 9-9 Consider the following table, which gives a security analyst’s expected return on two stocks in two particular scenarios for the rate of return on the market: Market Return Aggressive Stock Defensive Stock 5 % –3 % 3 % 27 34 11 a. What are the betas of the two stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.) b. What is the expected rate of return on each stock if the two scenarios for...

Consider the following table, which gives a security analyst's expected return on two stocks for two...

Consider the following table, which gives a security analyst's expected return on two stocks for two particular market returns: Market Return Aggressive Stock Defensive Stock 6.76 % 3.76 % 2.01 % 21.26 30.51 13.76 Required: (a) What are the betas of the two stocks? (Round your answers to 2 decimal places.) Beta A Beta D (b) What is the expected rate of return on each stock if the market return is equally likely to be 6.76% or...

Expected return on two stocks for two particular market returns: Market Return

Expected return on two stocks for two particular market returns: Market Return Aggressive Stock Defensive Stock 4% -5% 6% 20% 30% 15% What are the betas of the two stocks? What is the expected rate of return on each stock if the market return is equally likely to be 4% or 20%? If the T-bill rate is 5% and the market return is equally likely to be 4% or 20%, draw the SML for this economy. Please...

Expected return on two stocks for two particular market returns: Market Return Aggressive Stock Defensive Stock...

Expected return on two stocks for two particular market returns: Market Return Aggressive Stock Defensive Stock 2% -5% 3% 22% 35% 15% a. What are the betas of the two stocks? b. What is the expected rate of return on each stock if the market return is equally likely to be 2% or 22%? c. If the T-bill rate is 3% and the market return is equally likely to be 2% or 22%, draw the SML for this economy. d....

4.) Consider the expected return for two stocks in two different market conditions: Market Return...

4.) Consider the expected return for two stocks in two different market conditions: Market Return Aggressive Stock Defensive Stock 8% 5% 6% 20% 34% 14% a. What are the betas of the two stocks? b. What is the expected rate of return on each stock if the market return is equally likely to be 8% or 20%? c. What are the alphas of each?

Consider stocks of two companies A and B, the table below gives their expected returns and...

Consider stocks of two companies A and B, the table below gives their expected returns and standard deviation Expected return for Stock A 10% Expected return for Stock B 25% Standard deviation for Stock A 12% Standard deviation for Stock B 30% Plot the risk and expected return of portfolio of these two stocks for the following correlation coefficient : -1.0,-0.5,0.0,0.5,1.0

Subjects