2 QAs

School of Business

FIN 320

FIN320: Homework # 5

1. Suppose rf = 9%, rM = 14%, and βi = 1.3.

a. What is ri, the required rate of return on Stock i?

b. Now suppose that rf increases to 10%. (The market risk premium does not change.) How does this affect rM and ri?

c. Now assume that rf remains at 9%, but rM increases to 16%. (The market risk premium does not remain constant.) How would this affect ri?

2. Consider the following information for three stocks, Stocks X, Y, and Z. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is, the correlation coefficients are between 0 and 1.)

Fund Q has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%. The expected return on the market is 10.5%.

a. What is the expected return for each of the three stocks? (three numbers)

b. What is the Beta of Fund Q?

c. What is the expected return of Fund Q?

d. Would you expect the standard deviation of Fund Q to be less than 15%, equal to 15%, or greater than 15%? Explain.

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