8-2 Required rate of return: Assume that therisk free rate is 6% and the expecte

Question

8-2 Required rate of return: Assume that therisk free rate is 6% and the expected return on the market is 13%.What is the required rate of return on a stock with beta of0.7? 8-19 Evaluating risk and return: Stock X hasa 10% expected return, a beta coefficient of 0.9, and a 35%standard dievation of expected returns. Stock Y has a 12.5%expected retyrn , a beta coefficient of 1.2 and 25% standarddievation. The risk free rate is 6%, and the market risk premium is5%. a. cakculate each stocks coefficient of caration. b. which stock is riskier for a diversified investor? c.calculate wach stocks required rate of return. d. on the basis of the two stocks expecred and requiredreturns which stocks would be more attractive to a diversifiedinvestor? e. calculate the required return of a portoflo that has a$7500 invested in stock X and $2500 invested in stock Y. f. If the market risk premium increased to 6%, which of thetwo stocks would have the larget increase in its requiredreturn? 8-2 Required rate of return: Assume that therisk free rate is 6% and the expected return on the market is 13%.What is the required rate of return on a stock with beta of0.7? 8-19 Evaluating risk and return: Stock X hasa 10% expected return, a beta coefficient of 0.9, and a 35%standard dievation of expected returns. Stock Y has a 12.5%expected retyrn , a beta coefficient of 1.2 and 25% standarddievation. The risk free rate is 6%, and the market risk premium is5%. a. cakculate each stocks coefficient of caration. b. which stock is riskier for a diversified investor? c.calculate wach stocks required rate of return. d. on the basis of the two stocks expecred and requiredreturns which stocks would be more attractive to a diversifiedinvestor? e. calculate the required return of a portoflo that has a$7500 invested in stock X and $2500 invested in stock Y. f. If the market risk premium increased to 6%, which of thetwo stocks would have the larget increase in its requiredreturn?

Explanation / Answer

CalculatingRequired Rate of Return (RE): Risk-free Rate(Rf) = 6% Expected Return on the Market(RM) = 13% Stock Beta(ß) = 0.7 Reaquired Rate of Return(RE) = Rf + ß * (RM -Rf) Required Rate of Return(RE) = 0.06 + 0.7 (0.13 - 0.06) Required Rate of Return(RE) = 0.06 + 0.049 Required Rate ofReturn (RE) = 0.109 (or)10.9% (a) Calculating Coefficientof Variation: Coeficient ofVariation = Standard Deviation / ExpectedReturn Coefficient Variation of StockX = 0.35 / 0.10 Coefficient Variation ofStock X = 3.5 Coefficient Variation ofStock Y = 0.25 / 0.125 Coefficient Variation ofStock Y = 2 ( c )Calculating Stocks Required Rate of Return: Required Rate of Returnon Stock X = 0.06 + 0.9 * 0.05 Required Rate ofReturn on Stock X = 0.105 (or) 10.5% Required Rate of Returnon Stock Y = 0.06 + 1.2 * 0.05 Required Rate ofReturn on Stock Y = 0.12 (or) 12% (e) CalculatingRequired Return of Portfolio: Investment in StockX = $7,500 Investment in StockY = $2,500 TotalPortfolio             = $10,000 Portfolio Weights: Stock X = $7,500 /$10,000 = 0.75 Stock Y = $2,500 /$10,000   = 0.25 Expected Return on StockX   = 10% Expected Return on StockY =   12.5% Required Return of aPortfolio = 0.75 * 0.10 + 0.25 * 0.125 Required Return of aPortfolio = 0.75 * 0.10 + 0.25 * 0.125 Required Returnof a Portfolio = 0.10625 (or) 10.63% (f) If theMarket Risk Premium Increased to 6%: Required Return on StockX = 0.06 + 0.9 *0.06 Required Return on StockX = 0.114 (or) 11.4% Required Return on StockY = 0.06 + 1.2 * 0.06 Required Return on StockY = 0.132 (or) 13.2% StockY'sRequired Return is Increased to 13.2% Hope it may help you CalculatingRequired Rate of Return (RE): Risk-free Rate(Rf) = 6% Expected Return on the Market(RM) = 13% Stock Beta(ß) = 0.7 Reaquired Rate of Return(RE) = Rf + ß * (RM -Rf) Required Rate of Return(RE) = 0.06 + 0.7 (0.13 - 0.06) Required Rate of Return(RE) = 0.06 + 0.049 Required Rate ofReturn (RE) = 0.109 (or)10.9% (a) Calculating Coefficientof Variation: Coeficient ofVariation = Standard Deviation / ExpectedReturn Coefficient Variation of StockX = 0.35 / 0.10 Coefficient Variation ofStock X = 3.5 Coefficient Variation ofStock Y = 0.25 / 0.125 Coefficient Variation ofStock Y = 2 ( c )Calculating Stocks Required Rate of Return: Required Rate of Returnon Stock X = 0.06 + 0.9 * 0.05 Required Rate ofReturn on Stock X = 0.105 (or) 10.5% Required Rate of Returnon Stock Y = 0.06 + 1.2 * 0.05 Required Rate ofReturn on Stock Y = 0.12 (or) 12% (e) CalculatingRequired Return of Portfolio: Investment in StockX = $7,500 Investment in StockY = $2,500 TotalPortfolio             = $10,000 Portfolio Weights: Stock X = $7,500 /$10,000 = 0.75 Stock Y = $2,500 /$10,000   = 0.25 Expected Return on StockX   = 10% Expected Return on StockY =   12.5% Required Return of aPortfolio = 0.75 * 0.10 + 0.25 * 0.125 Required Return of aPortfolio = 0.75 * 0.10 + 0.25 * 0.125 Required Returnof a Portfolio = 0.10625 (or) 10.63% (f) If theMarket Risk Premium Increased to 6%: Required Return on StockX = 0.06 + 0.9 *0.06 Required Return on StockX = 0.114 (or) 11.4% Required Return on StockY = 0.06 + 1.2 * 0.06 Required Return on StockY = 0.132 (or) 13.2% StockY'sRequired Return is Increased to 13.2%

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