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Answers to Quiz #1 Finance 357 Business Finance (03085) 1. (2 points; Portfolio Risk ) Suppose the expected returns and standard deviations of stock A and B are E(R A )=0.15, E(R B )=0.20, SD A =0.1 and SD B =0.2, respectively. a. Calculate the expected return and standard deviation of a portfolio that is composed of 30 percent A and 70 percent B when the correlation between the returns on A and B is 0.5. b. Calculate the standard deviation of a portfolio that is composed of 30 percent A and 70 percent B when the correlation between the returns on A and B is -0.5. a. Expected return = (0.30)(0.15) + (0.70)(0.20) = 0.045 + 0.14 = 0.185 (18.5 percent) Portfolio variance = (0.30) 2 (0.10) 2 + (0.70) 2 (0.20) 2 + 2(0.30)(0.70)(0.5)(0.1)(0.2) = 0.0247 Portfolio SD = (0.0247) 1/2 = 0.157 b. Portfolio variance = (0.30) 2 (0.10) 2 + (0.70) 2 (0.20) 2 - 2(0.30)(0.70)(0.5)(0.1)(0.2) = 0.0163 Portfolio SD = (0.0163) 1/2 = 0.128 2. (1 point; CAPM ) Suppose the expected market risk premium is 8.5 percent and the risk-free rate is 3.5 percent. The expected return on TriStar’s stock is 20.5 percent. What is the beta of TriStar’s stock?

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