Tutorial 4 questions - Tutorial 4#1 In broad terms why is some risk diversifiable Why are some risks non-diversifiable Does it follow that an investor

Tutorial 4 questions - Tutorial 4#1 In broad terms why is...

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Unformatted text preview: Tutorial 4 #1: In broad terms, why is some risk diversifiable? Why are some risks non-diversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk? #2: Indicate whether the following events might cause stocks in general to change price, and whether they might cause Big Widget Corp.’s stock to change price: a. The government announces that inflation unexpectedly jumped by 2 percent last month. b. Big Widget’s quarterly earnings report, just issued, generally fell in line with analysts’ expectations. c. The government reports that economic growth last year was at 3 percent, which was generally agreed with most economists’ forecasts. d. The directors of Big Widget die in a plane crash. e. Congress approves changes to the tax code that will increase the top marginal corporate tax rate. The legislation had been debated for the previous six months. #3: Stock Y has a beta of 1.3 and an expected return of 18.5 percent. Stock Z has a beta of 0.70 and an expected return of 12.1 percent. If the risk-free rate is 8 percent and the market risk premium is 7.5 percent, are these stock correctly priced? #4: A stock has a beta of 1.35 and an expected return of 16%. A risk-free asset currently earns 4.8%. a. What is the expected return on a portfolio that is equally invested in the two assets? b. If a portfolio of the two assets has a beta of 0.95, what are the portfolio weights? c. If a portfolio of the two assets has an expected return of 8%, what is its beta? d. If a portfolio of the two assets has a beta of 2.70, what are the portfolio weights? How do you interpret the weights for the two assets in this case? Explain. #5: #5: Consider I and II:II: Considerthe thefollowing followinginformation informationabout aboutStock Stock I and State of Economy Recession Probability of State of Economy 0.25 Rate of Return if State Occurs Stock I Stock II 0.11 -0.40 Normal 0.50 0.29 0.10 Irrational exuberance 0.25 0.13 0.56 Themarket marketrisk riskpremium premiumisis8 8percent, percent,and andthethe risk-free rate 4 percent. Which stock The risk-free rate is is 4 percent. Which stock has the most has the most systematic risk? Which one has the most unsystematic risk? Which is systematic risk? Which one has the most unsystematic risk? Which stock is “riskier”?stock Explain. “riskier”? Explain. #6: Suppose you observe the following situation: Security Beta Expected Return Pete Corp 1.35 0.132 Repete Co. 0.80 0.101 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate? The market risk premium is 8 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is “riskier”? Explain. #6: #6: Suppose Supposeyou youobserve observe the the following following situation: situation: Security Beta Expected Return Pete Corp 1.35 0.132 Repete Co. 0.80 0.101 Assumethese thesesecurities securities are are correctly correctly priced. priced. Based Basedon onthe theCAPM, CAPM,what whatisisthe theexpected expectedreturn on the Assume return onWhat the market? What israte? the risk-free rate? market? is the risk-free #7: You are managing a portfolio of 6 stocks, which are held in equal dollar amounts. The current beta of the portfolio is 1.4, and the beta’s of Stock A is 1.8 and of Stock B is 2.0, respectively. If Stock A and Stock B are sold and the proceeds used to purchase 2 replacement stocks, what does the average beta of these 2 replacement stocks have to be to reduce the portfolio beta to 1.25? ...
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