The riskless return is currently 6%, and Chicago Gear hasestimated the contingen

Question

The riskless return is currently 6%, and Chicago Gear hasestimated the contingent returns given here.

a. Calculate the expected returns on the stock market and onChicago Gear stock.

b. What is Chicago Gear’s beta?

c. What is Chicago Gear’s required returnaccording to the CAPM?

REALIZED RETURN

State of the Market

Probability that State Occurs

Stock Market

Chicago Gear

Stagnant

0.20

(10%)

(15%)

Slow Growth

0.35

10

15

Average Growth

0.30

15

25

Rapid Growth

0.15

25

35

REALIZED RETURN

State of the Market

Probability that State Occurs

Stock Market

Chicago Gear

Stagnant

0.20

(10%)

(15%)

Slow Growth

0.35

10

15

Average Growth

0.30

15

25

Rapid Growth

0.15

25

35

Explanation / Answer

(a)Calculating Expected Returns on the Stock Market and on ChicagoGear Stock: Expected Return on StockMarket E(Rstock market) = [(0.20 * -0.10) + (0.35 *0.10) + (0.30 * 0.15) + (0.15 * 0.25) Expected Return on StockMarket E(Rstock market) = [-0.02 + 0.035 + 0.045 +0.0375] Expected Return on StockMarket E(Rstock market) = 0.0975 (or)9.75% Expected Returnon Stock Market E(Rstockmarket) = 9.75% Expected Return onChicago Gear E(Rchicago gear) = [(0.20 *-0.15) + (0.35 * 0.15) + (0.30 * 0.25) + (0.15 * 0.35)] Expected Return onChicago Gear E(Rchicago gear) = [-0.03 +0.0525 + 0.075 + 0.0525] Expected Return onChicago Gear E(Rchicago gear) = 0.15 (or)15% Expected Returnon Chicago Gear E(Rchicago gear) =15% (b) Calculating ChicagoGear's Beta(ß): Average Realized Returnon Chicago Gear = [-0.15 + 0.15 + 0.25 + 0.35] / 4 Average Realized Returnon Chicago Gear = 0.15 (or) 15% Expected Return onChicago Gear E(Rchicagogear) = 15% Risk-free Return(Rf) = 6% 0.15 = 0.06 + Beta (ß) * (0.15- 0.06) 0.15 = 0.06 + ß *0.09 0.15 - 0.06 = ß *0.09 0.09 = ß * 0.09 ß * 0.09 = 0.09 ß = 0.09 /0.09 Beta Value (ß) =1 ( c)   Calculating Chicago Gear's Required Return accordingto the CAPM: According to CAPM, theRequired Return (RE) = Rf + ß(RM - Rf) Required Return ofChicago Gear's Required Return (Rchicago gear's) =0.06 + 1 (0.15 - 0.06) Required Return ofChicago Gear's Required Return (Rchicago gear's) =0.06 + 1 (0.09) Required Return ofChicago Gear's Required Return (Rchicago gear's) =0.06 + 0.09 Required Returnof Chicago Gear's Required Return (Rchicagogear's) = 0.15 (or) 15% (a)Calculating Expected Returns on the Stock Market and on ChicagoGear Stock: Expected Return on StockMarket E(Rstock market) = [(0.20 * -0.10) + (0.35 *0.10) + (0.30 * 0.15) + (0.15 * 0.25) Expected Return on StockMarket E(Rstock market) = [-0.02 + 0.035 + 0.045 +0.0375] Expected Return on StockMarket E(Rstock market) = 0.0975 (or)9.75% Expected Returnon Stock Market E(Rstockmarket) = 9.75% Expected Return onChicago Gear E(Rchicago gear) = [(0.20 *-0.15) + (0.35 * 0.15) + (0.30 * 0.25) + (0.15 * 0.35)] Expected Return onChicago Gear E(Rchicago gear) = [-0.03 +0.0525 + 0.075 + 0.0525] Expected Return onChicago Gear E(Rchicago gear) = 0.15 (or)15% Expected Returnon Chicago Gear E(Rchicago gear) =15% (b) Calculating ChicagoGear's Beta(ß): Average Realized Returnon Chicago Gear = [-0.15 + 0.15 + 0.25 + 0.35] / 4 Average Realized Returnon Chicago Gear = 0.15 (or) 15% Expected Return onChicago Gear E(Rchicagogear) = 15% Risk-free Return(Rf) = 6% 0.15 = 0.06 + Beta (ß) * (0.15- 0.06) 0.15 = 0.06 + ß *0.09 0.15 - 0.06 = ß *0.09 0.09 = ß * 0.09 ß * 0.09 = 0.09 ß = 0.09 /0.09 Beta Value (ß) =1 ( c)   Calculating Chicago Gear's Required Return accordingto the CAPM: According to CAPM, theRequired Return (RE) = Rf + ß(RM - Rf) Required Return ofChicago Gear's Required Return (Rchicago gear's) =0.06 + 1 (0.15 - 0.06) Required Return ofChicago Gear's Required Return (Rchicago gear's) =0.06 + 1 (0.09) Required Return ofChicago Gear's Required Return (Rchicago gear's) =0.06 + 0.09 Required Returnof Chicago Gear's Required Return (Rchicagogear's) = 0.15 (or) 15%

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.