Homework Key
Risk, Return, and Capital Budgeting
7.
Required return = r
f
+
β
(r
m
– r
f
) = 6% + [1.25
×
(13% – 6%)] = 14.75%
Expected return = 16%
The security is underpriced.
Its expected return is greater than the required return
given its risk.
8.
Beta tells us how sensitive the stock return is to changes in market performance.
The
market return was 4 percent less than your prior expectation (10% versus 14%).
Therefore, the stock would be expected to fall short of your original expectation by:
0.8
×
4% = 3.2%
The ‘updated’ expectation for the stock return is: 12% – 3.2% = 8.8%
10.
The following table shows the
average
return on Tumblehome for various values of the
market return.
It is clear from the table that, when the market return increases by 1%,
Tumblehome’s return increases, on average, by 1.5%.
Therefore,
β
= 1.5.
If you
prepare a plot of the return on Tumblehome as a function of the market return, you will
find that the slope of the line through the points is 1.5.
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 Winter '10
 jerry
 Financial Markets, Modern portfolio theory, Tumblehome

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