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Problem 7.7
Part (a)
Notes:
•
Beta is the sensitivity
ofthe
stock return to the market return therefore;
Beta
is the change
in the return per unit change
in the market return
•
We will compute
each stock's
Beta by calculating
the difference
in its return
across the two scenarios
divided
by the difference
in the market
return.
Using the Aggressive
(A) as an example:
Beta A= Cov (RA. RM)
Var (RM)
A "quick
and dirty way" of calculating
the Betas will be:
Beta A= 232
= 2.00
520
Beta 0=
3.5 14 = 0.70
520
Part (b)
If the two scenarios
are equally
likely, then the expected
rate of return is the average
of the two outcomes
or a 50%/50%
probability
E(rA) = 0.5 x (2%
+ 32%)
= 17%
Mean return of A
E(rD) = 0.5 x (3.5% + 14%) = 8.75% Mean return of 0
Part (c)
The SML is determined
by: The Tbill rate of 8% and the beta of zero; the expected
rate of return for the market
is 12.5% (calculated
as: 0.5 x (20% +5%) = 12.5%) and
the Beta 1.
The equation
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 Fall '10
 Martinez

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