1. 2. 3. Hastings Entertainment has a beta of 0.71. If the market return is expe
ID: 3147530 • Letter: 1
Question
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Hastings Entertainment has a beta of 0.71. If the market return is expected to be 17.50 percent and the risk-free rate is 8.50 percent, what is Hastings’ required return?
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You have a portfolio with a beta of 1.59. What will be the new portfolio beta if you keep 86 percent of your money in the old portfolio and 14 percent in a stock with a beta of 0.58?
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A manager believes his firm will earn a 20.10 percent return next year. His firm has a beta of 1.55, the expected return on the market is 16.50 percent, and the risk-free rate is 6.50 percent.
Compute the return the firm should earn given its level of risk.
Determine whether the manager is saying the firm is undervalued or overvalued.
The average annual return on an Index from 1986 to 1995 was 14.20 percent. The average annual T-bill yield during the same period was 6.40 percent. Compute the expected return given these three economic states, their likelihoods, and the potential returns: (Round your answer to 2 decimal places.) Economic State Fast growth Slow growth Recession Probability Return 0.31 0.43 0.26 -33 32% 20 Expected returnExplanation / Answer
1. Expected return = (p1 X return)+(p2 X return)+(p3 X return)
0.31×32% + 0.43×20% + 0.26×-33% = 9.94%
2. Market rate premium is calculated by the following formula
Market risk premium =Index Rate -T Bill Rate
MRp=14.20-6.4=7.8 for the ten years
3 The formula for the capital asset pricing model is:
Expected Return=Risk Free rate+ betaXMarket Risk Premium(market rate-risk free rate)
Expected return=8.50% + 0.71 x (17.50%-8.50%)=14.89%
4 New portfolio beta = 0.86×1.59 + 0.14×0.58 = 1.4486 or 1.45(in two decimal)
5. The firm’s required return =6.50%+1.55 x (16.50% - 6.50%)=22%
Since the return required for the level of risk is 22% and the manager believes a 20.10% return will be achieved, the manager is saying the firm is over-valued.
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