This is the second time I have posted this, and the first answer that I got did
ID: 2612286 • Letter: T
Question
This is the second time I have posted this, and the first answer that I got did not seem correct. Please give it careful consideration, especially to the Correlation Coefficient listed for each stock. Maybe the key is to extract the Covariance from the stock and market deviations and Correlation Coefficients given, and use it to calculate the betas? Thanks!
Estimate the beta of the following stocks assuming the standard deviation of the market returns is 7 percent. The expected return, standard deviation are given. The correlation coefficient is between the stock and the market. Use a 3 percent risk free rate and a 7 percent equity/market risk premium.
Stock Expected Return Standard Deviation CorrelationCoefficient
P 12% 10% 0.80
Q 18% 20% 0.60
R 15% 15% 0.40
a. What is the beta for each stock?
b. What is the required return for each stock?
c. Which stocks, if any, would you purchase?
Explanation / Answer
Security
Expected return
Standard Deviation
Correlation Coefficient
P
12
10
0.8
Q
18
20
0.6
R
15
15
0.4
stock
Computation
Beta
P
=0.8*0.1*0.07/(0.07*0.07)
1.143
Q
=0.6*0.2*0.07/(0.07*0.07)
1.714
R
=0.15*0.4*0.07/(0.07*0.07)
0.857
What is the required return for each stock?
Rf+beta(riskpremium)
Rf
3
Risk premium
7
Beta
P
1.143
Q
1.714
R
0.857
Stock
Required return for each stock in%
P
11.00
Q
15.00
R
9.00
R look more attractive than other as the expected return is more than the required return
Security
Expected return
Standard Deviation
Correlation Coefficient
P
12
10
0.8
Q
18
20
0.6
R
15
15
0.4
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