Q4) Suppose that the best predictor for a stock’s future beta is determined to be Expected beta=0.33+0.67(historical beta).
The
historical beta is calculated as 1.2. The risk-free rate is 5 percent, and the market risk premium is 8.5 percent. Calculate the expected
return on the stock using expected (adjusted) beta in the CAPM.
Q5) The market has an expected return of 11 percent, and the risk-free rate is 5 percent. Pfizer has a beta of .9. What is the required
rate of return for Pfizer?
Q6) The market has an expected return of 12 percent, and the risk-free rate is 5 percent. Activalue Corp. is 80 percent as risky as the
market as a whole. What is the required rate of return for this company?
Q7) Electron Corporation is 50 percent more volatile than the market as a whole. The market risk premium is 7 percent. The risk-free
rate is 5 percent. What is the required rate of return for Electron?
Beta = 1 + (1*0.5) = 1.5
Q8) The expected return for the market is 12 percent, and the risk-free rate is 8 percent. The following information is available for
each of five stocks.
a. Calculate the required return for each stock.
b. Assume that an investor, using fundamental analysis, develops the estimates of expected return labeled E (R i) for these stocks.
Determine which stocks are undervalued and which are overvalued.
c. What is the market’s risk premium?
Q9) Assume that the risk-free rate is 7 percent and the expected market return is 13 percent. Show that the security market line is E
(Ri)= 7.0 + 6.0β. Assume that an investor has estimated the following values for six different corporations. Calculate the E(R i) for
each corporation using the SML, and evaluate which securities are overvalued and which are undervalued.
Q10) Assume that Exxon is priced in equilibrium. Its expected return next year is 14 percent, and its beta is 1.1. The risk-free rate is 6
percent.
a. Calculate the expected return on the market.
b. Calculate the slope of the SML.
Q11) Given the following information: Expected return for the market, 12 percent; Standard deviation of market return, 21 percent;
Risk-free rate, 8 percent; Correlation coefficient between Stock A and the market, 0.8; Stock B and the market, 0.6; Standard
deviation for stock A, 25 percent; Standard deviation for stock B, 30 percent.
a. Calculate the beta for stock A and stock B.
b. Calculate the required return for each stock.
Q4) Suppose that the best predictor for a stock’s future beta is determined to be Expected beta=0.33+0.67(historical beta). The
historical beta is calculated as 1.2. The risk-free rate is 5 percent, and the market risk premium is 8.5 percent. Calculate the expected
return on the stock using expected (adjusted) beta in the CAPM.
βadj = 0.33 + (0.67)(1.2)
= 0.33 + 0.80
= 1.13
E(RP)= E (Ri) = RF + βi[E(RM) – RF]
= 5% + 1.13 (8.5%)
= 14.6%
Q5) The market has an expected return of 11 percent, and the risk-free rate is 5 percent. Pfizer has a beta of .9. What is the required
rate of return for Pfizer?
Ans k = 5 + .9[11-5] = ……(%)
Q6) The market has an expected return of 12 percent, and the risk-free rate is 5 percent. Activalue Corp. is 80 percent as risky as the
market as a whole. What is the required rate of return for this company?
Ans k = 5 + .8[12-5] = …….(%)
B= 1*0.8=0.8
Q7) Electron Corporation is 50 percent more volatile than the market as a whole. The market risk premium is 7 percent. The risk-free
rate is 5 percent. What is the required rate of return for Electron?
1*0.5 + 1 = 1.5
k = 5 + 1.5[7] = …….(%)
Q8) The expected return for the market is 12 percent, and the risk-free rate is 8 percent. The following information is available for
each of five stocks.
a. Calculate the required return for each stock.
b. Assume that an investor, using fundamental analysis, develops the estimates of expected return labeled E (R i) for these stocks.
Determine which stocks are undervalued and which are overvalued.
c. What is the market’s risk premium?
(a) From the SML:
Stock 1 8 + .9(4) = 11.6% ------U.V
2 8 + 1.3(4) = 13.2.%-------O.V
3 8 + .5(4) = 10%---------U.V
4 8 + 1.1(4) = 12.4%--------U.V
5 8 + 1.0(4) =12% --------- FAIRLY PRICED
(b) Funds …… and ……are undervalued because each has an expected return greater than its
required return as given by the SML. Funds …… and ……. are overvalued because each has an
expected return lower than its required returns given by the SML.
(c) The slope of the SML, or (12-8) = 4(%).
Q9) Assume that the risk-free rate is 7 percent and the expected market return is 13 percent. Show that the security market line is E
(Ri)= 7.0 + 6.0β. Assume that an investor has estimated the following values for six different corporations. Calculate the E(R i) for
each corporation using the SML, and evaluate which securities are overvalued and which are undervalued.
E(Ri) = 7.0 + (13.0-7.0)βi = 7.0 + 6.0βi
GF 7 + 6( .8) = 11.8% < 12% undervalued
PepsiCo 7 + 6( .9) = 12.4% < 13% undervalued
IBM 7 + 6(1.0) = 13.0% < 14% undervalued
NCNB 7 + 6(1.2) = 14.2% > 11% overvalued
EG&G 7 + 6(1.2) = 14.2% < 21% undervalued
EAL 7 + 6(1.5) = 16.0% > 10% overvalued
Q10) Assume that Exxon is priced in equilibrium. Its expected return next year is 14 percent, and its beta is 1.1. The risk-free rate is 6
percent.
a. Calculate the expected return on the market.
b. Calculate the slope of the SML.
If Exxon is in equilibrium, the relationship is:
14 = RF + [E(RM) - RF] ß
14 = 6 + [E(RM) - 6]× 1.1
E(RM)=……13.27……%
Therefore,
a. the slope of the SML must be [E(RM ) - 6] or approximately …7.27…..% in order for the
relationship to hold on both sides
Q11) Given the following information: Expected return for the market, 12 percent; Standard deviation of market return, 21 percent;
Risk-free rate, 8 percent; Correlation coefficient between Stock A and the market, 0.8; Stock B and the market, 0.6; Standard
deviation for stock A, 25 percent; Standard deviation for stock B, 30 percent.
a. Calculate the beta for stock A and stock B.
b. Calculate the required return for each stock.
(a) In order to calculate the beta for each stock, it is necessary to calculate each of the
covariances with the market, using the correlation coefficient for the stock with the
market, the standard deviation of the stock, and the standard deviation of the market.
Corr Coeff = CovA,B / S.DA * S.DB
CovA,B. = Corr coeff * S.DA * S.DB
BA= CovA,M/VarM
Stock A cov = (.8)(25)(21) = 420%
beta = 420/(21)2 = 1.05 0.95
BB = CovB,M/VarM
Stock B cov = (.6)(30)(21) = 378
beta = 378/(21)2 = .95 0.85
(b) From the SML, Ri = 4 + (12-4)βi
Stock A = 4 + (12-4)(1.05) = 12.4%
Stock B = 4 + (12-4)(.95) = 11.6%
