27) Dinner Foods stock has a beta of 1.45 and an expected return of 13.43 percen

Question

27) Dinner Foods stock has a beta of 1.45 and an expected return of 13.43 percent. Edwards' Meals stock has a beta of .95 and an expected return of 10.27 percent. Assume that both stocks are correctly priced. Given this, the risk-free rate is percent and the market rate of return is percent. A) 4.02; 1153 B) 4.09; 12.35 C) 4.10; 11.53 D) 4.27; 10.59 E) 4.41; 10.25 28) What is the covariance of security A to the market given the following information? YearSecurity A ReturnsMarket Returns A) 75.0 B) 80.1 C) 83.8 D) 87.0 E) 91.1

Explanation / Answer

27.

For Dinner Food.

According to CAPM model:

Expected return = rf + risk premium × beta

               13.43%   = rf + risk premium × 1.45 ……………………………. (1)

Again

For Edward Meal

Beta = 0.95

Expected return = 10.27%

Risk free rate = rf

According to CAPM model:

Expected return = rf + risk premium × beta

               10.27% = rf + risk premium × 0.95 ……………………………. (1)

Gain Equation 1 – Equation 2

3.16% = 0.50 × Risk premium

Risk premium = 6.32%.

Now risk-free rate is calculated below:

Risk free rate = 13.43% - 6.32% × 1.45

                       = 4.27%

Hence, risk free rate is 4.27%

Now market return = Risk free rate + risk premium

                             = 4.27% + 6.32%

                               = 10.59%

Hence, Market return is 10.59%.

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