The stock of Jones Trucking is expected to return 15 percent annually with a sta
ID: 2615212 • Letter: T
Question
The stock of Jones Trucking is expected to return 15 percent annually with a standard deviation of 7 percent. The stock of Bush Steel Mills is expected to return 19 percent annually with a standard deviation of 10 percent. The correlation between the returns from the two securities has been estimated to be +0.3. The beta of the Jones stock is 1.2, and the beta of the Bush stock is 1.5. The risk-free rate of return is expected to be 6 percent, and the expected return on the market portfolio is 14 percent. The current dividend for Jones is $4. The current dividend for Bush is $6.
Required return (Bush): %
The -(Jones or Bush) stock is the better buy because the expected return is (lower or higher) than the required return.
What is the expected return from a portfolio containing the two securities if 30 percent of your wealth is invested in Jones and 70 percent is invested in Bush? Round your answer to one decimal place. % What is the expected standard deviation of the portfolio of the two stocks? Round your answer to two decimal places. % Which stock is the better buy in the current market? Round your answers to one decimal place. Required return (Jones): %Required return (Bush): %
The -(Jones or Bush) stock is the better buy because the expected return is (lower or higher) than the required return.
Explanation / Answer
1.Expected return of Portfolio = Weight of Jones Trucking * Expected return of Jones Trucking + Weight of Bush Steel Mills * Expecetd return of Bush Steel Mills = 0.3 *15% + 0.7 * 19% = 17.8%
2. Standard deviation = [( Weight of Jones Trucking * Standard Deviation of Jones Trucking)2+ (Weight of Bush Steel Mills * Standard Deiation of Bush Steel Mills)2 + 2* Weight of Jones Trucking * Standard Deviation of Jones Trucking*Weight of Bush Steel Mills * Standard Deiation of Bush Steel Mills* Correlation]1/2
=[ (0.3*0.07)2 + (0.7 * 0.1)2 + 2* 0.3 * 0.07 * 0.7 * 0.1 * 0.3]1/2 = 7.89%
3.According to Capm Required return of Jones Trucking = Risk Free Rate + Beta * ( Market Return - Risk Free Rate) = 6% + 1.2 * ( 14% -6%) =15.6%
4. According to Capm Required return of Bush Steel Mills = Risk Free Rate + Beta * ( Market Return - Risk Free Rate) = 6% + 1.5 * ( 14% -6%) =18%
5.The ( Bush) stock is the better buy because the expected return is ( higher) than the required return
Expected return =19% and required rate = 18%
Best of Luck. God Bless
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