1-Problem 10-19 Under-/Overvalued Stock (LG10-3) A manager believes his firm wil
ID: 2781616 • Letter: 1
Question
1-Problem 10-19 Under-/Overvalued Stock (LG10-3)
A manager believes his firm will earn a return of 19.40 percent next year. His firm has a beta of 1.67, the expected return on the market is 11.20 percent, and the risk-free rate is 3.20 percent.
Compute the return the firm should earn given its level of risk. (Round your answer to 2 decimal places.)
required return =......%
2-Problem 10-22 Portfolio Beta (LG10-3)
You own $20,384 of Human Genome stock that has an assumed beta of 2.51. You also own $12,740 of Frozen Food Express (assumed beta = 2.38) and $3,276 of Molecular Devices (assumed beta = 0.93).
What is the beta of your portfolio? (Round your answer to 2 decimal places.)
portfolio beta=.....%
Explanation / Answer
1.
According to CAPM,
Required return = risk free rate + beta*(Market return - risk free rate)
= 3.2% + 1.67*(11.2-3.2) = 16.56%
But the manager is expecting, 19.40%, so the stock is overvalued.
2.
Total vaue of the portfolio = 20384 + 12740 + 3276 = 36400
Weight of Human geonome in portfolio = 20384/36400 = 0.56
Weight of Frozen food = 12740/36400 = 0.35
Weight of Molecular devices = 3276/36400 = 0.09
Portfolio beta is the weighted average of individual betas:
Portfolio beta = 0.56*2.51 + 0.35*2.38 + 0.09*0.93 = 2.32
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