Answered: a) The expected return of Stock A b)…

a) The expected return of Stock A b) The expected return of Stock B c) The expected return of Portfolio where you invest $15,000 in Stock A and $25,000 in Stock B

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 20P

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Concept explainers

Stock Market Indices

Stock indexes are used to compare the price fluctuations of a group of stocks of similar companies, which are combined based on a similar industry or a particular market capitalization limit or type of market. The price comparison is based on a pre-determined standard method or indicators. These stock indexes are usually considered a base for comparison of a particular stock, and the performance of that particular company can be easily determined.

Question

Based on the following information Calculate

State of Economy	Probability of State of Economy	Rate of Return if State Occurs
Stock A	Stock B
Recession	0.25	0.05	-0.17
Normal	0.45	0.08	0.12
Boom	0.30	0.13	0.29

a) The expected return of Stock A

b) The expected return of Stock B

c) The expected return of Portfolio where you invest $15,000 in Stock A and $25,000 in Stock B

d) Suppose Stock A has a beta of 0.8 and Stock B has a beta of 1.2. If you invest $15,000 in Stock A and $25,000 in Stock B, what is the beta of this portfolio?

e) Expected return on the market (R_M) is 12% and the risk-free (r_f) is 3%. What must the expected return on the portfolio according to CAPM? (Use the beta you have calculated in section d) for CAPM)

Definition Definition Model that illustrates the correlation between the expected return and risk of capital investment in stock. According to this model, the expected rate of return on equity is equal to the risk-free return added to a risk premium, which is based on the stock beta.

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