Question 22 Stock Y has an expected return of 14% and beta of 1.80. Stock Z has

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Question 22

Stock Y has an expected return of 14% and beta of 1.80. Stock Z has an expected return of 11.50% and beta of 1.10. If the risk-free rate is 3.5% and the market risk premium is 6.5%, which security is overvalued?

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Question 23

ABC Inc.'s stock has a 40% chance of producing a 8.6% return, a 25% chance of producing a 11.2% return, and a 35% chance of producing a 21.7% return. What is ABC Inc's expected return?

Enter your answer in percentages rounded off to two decimal points. Do not type % in the answer box.

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Question 24

The common stock of ABC has a beta of 1.22. The market risk premium is 10.7 percent and the risk-free rate is 3.1 percent. What is the firm’s expected return, E(Ri)?

Hint: Use the CAPM equation to get the answer.

Enter your answer in percentages rounded off to two decimal points. Do not enter % in the answer box.

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Question 25

You own a portfolio invested 28.44% in Stock A, 14.81% in Stock B, 27.19% in Stock C, and the remainder in Stock D. The beta of these four stocks are 0.78, 1.14, 0.34, and 1.04. What is the portfolio beta?

Note: Enter your answer rounded off to two decimal points. For example, if your answer is 12.345 then enter as 12.35 in the answer box.

Explanation / Answer

22...According to the CAPM,SML equation is as follows: Reqd. return on Equity, ke=RFR+Beta*Market risk premium So, calculating the reqd. return on Stock Y, 3.5%+(1.8*6.5%)= 15.20% AS the expected return in the market for this stock is 14% , for this measure of beta,it will be plotted below the SML in the graph. It is overvalued in price because return of 14% does not seem to overcome the risks associated with the stock. Similarly,, calculating the reqd. return on Stock Z, 3.5%+(1.1*6.5%)= 10.65% AS the expected return in the market for this stock is 11.5% , for this measure of beta,it will be plotted above the SML in the graph. Hence Stock Z is under-valued in price because of its greater return of 11.5%   that overcomes the risks associated with the stock. So, ANSWER is: Security that is overvalued is: Stock Y, because it plots below the SML 23..ABC's expected reurn =Sum of all probable returns ie.ABC's expected Return=(40%*8.6%)+(25%*11.2%)+(35%*21.7%)= 13.84% 24…AS per CAPM, The expected return of ABC=3.1%+(1.22*10.7%) 16.15% 25..The portfolio beta is the weighted beta of its individual components ie. (28.44%*0.78)+(14.81%*1.14)+(27.19%*0.34)+(29.56%*1.04)= 0.79

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