HW7_Answers

HW7_Answers - Answers to End-of-Chapter Questions Q7-1....

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Answers to End-of-Chapter Questions Q7-1. Based on the charts below, which stock has more systematic risk , and which stock has more unsystematic risk ? Stock #1 -30 -20 -10 0 10 20 30 -30 -20 -10 0 10 20 30 Market return Stock return Stock #2 -30 -20 -10 0 10 20 30 -30 -20 -10 0 10 20 30 Market return 177
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A7-1. The trend line is steeper for stock #1, so it is more sensitive to market movements and has higher systematic risk. Most of the points cluster tightly around the line for stock #1, but not so for stock #2. Most of stock #2’s risk is unsystematic. Q7-6. According to the capital asset pricing model, is the following data possible? Asset Return Std. Dev. #1 4% 0% #2 2% 20% A7-6. Yes, this is possible. The first asset is the risk-free asset with a 4% return an no standard deviation. The second asset is risky in the sense that its standard deviation is positive, but it offers a return below a T-bill. However, this is possible if the asset’s beta is negative. Q7-11. Explain why market efficiency implies that a well-run company is not necessarily a good investment? A7-11. An efficient market will recognize the talent of a firm’s managers and price that into the shares. That is, other things being equal, the stock price will be higher for firms with better managers. Therefore, the value of the talent is already incorporated into the price and can’t lead to higher returns unless the managers are even better than the market already thinks. Solutions to End-of-Chapter Problems P7-2. The table below shows the difference in returns between stocks and Treasury bills and the difference between stocks and Treasury bonds at 10-year intervals. Stocks vs. Bonds Stocks vs. Bills 1964-73 3.7% 8.3% 1974-83 0.2% 8.6% 1984-93 7.5% 5.4% 1994-2003 4.8% 2.1% a. At the end of 1973, the yield on Treasury bonds was 6.6% and the yield on T-bills was 7.2%. Using these figures and the historical data above from 1964-1973, construct two estimates of the expected return on equities as of December 1973. b. At the end of 1983, the yield on Treasury bonds was 6.6% and the yield on T-bills was 7.2%. Using these figures and the historical data above from 1974-1983, construct two estimates of the expected return on equities as of December 1983. c. At the end of 1993, the yield on Treasury bonds was 6.6% and the yield on T-bills was 2.8%. Using these figures and the historical data above from 1984-1993, construct two estimates of the expected return on equities as of December 1993. d.
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This note was uploaded on 03/21/2011 for the course FI 360 taught by Professor Tavbin during the Spring '08 term at Park.

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HW7_Answers - Answers to End-of-Chapter Questions Q7-1....

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