OD, 31.5% 10 points QUESTION 4 The market risk premium is 14% and the risk-free

Question

OD, 31.5% 10 points QUESTION 4 The market risk premium is 14% and the risk-free rate is 6%. What is the expected return on a stock with beta 1.4? OA. 6.4% B. 25.6% ° C. 17.6% D. 15.4% 10 points QUESTION 5 The risk-free rate is 5%. The expected return on the market is 10%. An equal-weighted portfolio of stocks A and B (meaning half of your money is in A and the other half in B) has an expected return of 11%. If stock A has beta= 1.4, what must be the expected return of stock B? 0A.5% B. 1296 C. 8% OD, 1096

Explanation / Answer

1

Option B

As per CAPM, return=risk free+ beta* market risk premium

So, return=6+1.4*14=25.6%

2 Option D

Let the beta of B be x

Beta of A=1.4

Proportion in A=0.5

Proportion in B=0.5

So, portfolio beta=0.5*1.4+0.5*x=0.7+0.5x

As per CAPM, return=risk free+beta*market risk premium

market risk premium=market return - risk free

=>market risk premium=10-5=5%

So, portfolio return=5+(0.7+0.5x)*5

Given , portfolio returns=11%

Hence, 5+(0.7+0.5x)*5=11

=>x=1

So, beta of B=1

return on B=5+1*5=10%

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