You own $16,095 of Denny’s Corp stock that has an assumed beta of 3.27. You also

Question

You own $16,095 of Denny’s Corp stock that has an assumed beta of 3.27. You also own $17,835 of Qwest Communications (assumed beta = 1.74) and $9,570 of Southwest Airlines (assumed beta = 0.76). Assume that the market return will be 15.0 percent and the risk-free rate is 9.0 percent.

What is the risk premium of each stock? (Round your answers to 2 decimal places.)

What is the risk premium of the portfolio? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

You own $16,095 of Denny’s Corp stock that has an assumed beta of 3.27. You also own $17,835 of Qwest Communications (assumed beta = 1.74) and $9,570 of Southwest Airlines (assumed beta = 0.76). Assume that the market return will be 15.0 percent and the risk-free rate is 9.0 percent.

Explanation / Answer

a.

Market risk premium = Return on market - risk free rate = 15% - 9% = 6%

b.

According to CAPM,

Stock's risk premium = beta*market risk premium

Denny's risk premium = 3.27*6% = 19.62%

Qwest's risk premium = 1.74*6% = 10.44%

Southwest airlines risk premium = 0.76*6% = 4.56%

c.

Find the portfolio beta:

Portfolio beta is the weighted average of individual betas.

Total investment value = 16095+17835+9570 = 43500

Weight of Denny's = 16095/43500 = 0.37

Weight of Qwest = 17835/43500 = 0.41

Weight of Southwest = 9570/43500 = 0.22

Portfolio beta = 0.37*3.27 + 0.41*1.74 + 0.22*0.76 = 2.0905

Portfolio risk premium = 2.0905*6% = 12.54%

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