Chap7_solution

# Chap7_solution - Suggested Solutions to Selected Chap 7...

This preview shows pages 1–3. Sign up to view the full content.

Suggested Solutions to Selected Chap 7 problems Fin 367 Spring 2008 Professor Bing Han Chapter 7: 1. a, c and d. 7. a. The beta is the sensitivity of the stock's return to the market return. Call A the aggressive stock and D the defensive stock. Then beta is the change in the stock return per unit change in the market return. Therefore, we compute each stock's beta by calculating the difference in its return across the two scenarios divided by the difference in market return. 00 . 2 20 5 32 2 A = - - = β 70 . 0 20 5 14 5 . 3 D = - - = β b. With the two scenarios equal likely, the expected rate of return is an average of the two possible outcomes: E(r A ) = 0.5 × (2% + 32%) = 17% E(r B ) = 0.5 × (3.5% + 14%) = 8.75% c. The SML is determined by the following: T-bill rate = 8% with a beta equal to zero, beta for the market is 1.0, and the expected rate of return for the market is: 0.5 × (20% + 5%) = 12.5% See the following graph.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
E(r) β 8% 12.5% 1.0 2.0 A SML M .7 α D D The equation for the security market line is: E(r) = 8% + β (12.5% – 8%) d. The aggressive stock has a fair expected rate of return of:
This is the end of the preview. Sign up to access the rest of the document.

## This note was uploaded on 05/10/2008 for the course FIN 367 taught by Professor Han during the Spring '08 term at University of Texas.

### Page1 / 5

Chap7_solution - Suggested Solutions to Selected Chap 7...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online