You have recently purchased stock in Topical Inc. which has returned between 6%

Question

You have recently purchased stock in Topical Inc. which has returned between 6% and 9% over the last three years. Your friend, Bob, has criticized your purchase and insists that you should have invested in Combs Inc., as he did, because it's been returning between 11% and 14% in the last three years. Bob knows nothing about financial theory. Topical's beta is 0.7 and Comb's is 1.4. Treasury bills are currently yielding the risk free rate of 4%, while the stock market is returning an average rate of 9%.

What return should you expect from Topical? Round the answer to two decimal places.

What return should Bob expect from Combs? Round the answer to two decimal places.

Explanation / Answer

Ans) Return you should expect from Topical

                       Kr = Krf + Beta(Km - Krf)

                           = 4% + 0.7( 9% - 4% )

                           = 4% + 3.5% = 7.5%

       Return bomb should expect from combs

                    Kr = Krf + Beta( Km - Krf)

                        = 4% + 1.4(9% - 4%)

                        = 4% + 7% = 11%

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